Commentary
When discussing monetary policy, the importance of interest rates accurately reflecting inflation and risk is often overlooked. Interest rates essentially represent the price of risk, and artificially manipulating them can lead to financial bubbles that eventually burst into crises. On the other hand, setting rates too high can harm the economy. Ideally, interest rates should be allowed to fluctuate naturally without central bank intervention. Such a system would help prevent the creation of bubbles and excessive risk accumulation. The risks associated with fixing rates too high are avoided when central banks set reference rates, making it easier for the government to borrow money—essentially creating currency artificially in a way that is convenient and cost-effective, without causing distortions.
Many argue that central banks do not set interest rates; they simply respond to market demand. However, this notion is contradicted by the fact that financial traders anxiously await rate decisions, indicating that the central bank’s actions have a significant impact. If the central bank truly only followed market demand, it would make sense to allow interest rates to float freely.
While the general public may view raising interest rates during high inflation as harmful, the real danger lies in having negative real and nominal interest rates. These low rates encourage individuals and businesses to take on excessive risks and accumulate debt under a false sense of security. It is ironic that people celebrate low rates but then complain when asset prices rise rapidly.
Inflation can benefit the entity issuing the currency, as it tends to blame external factors for price increases rather than acknowledging the role of excessive currency creation and artificially low interest rates in driving up prices. Blaming high interest rates on banks and consumer prices on supermarkets is a tactic often employed to shift responsibility away from the true culprits.
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The responsibility for printing currency and masking risks lies with entities like the European Central Bank (ECB) and the U.S. Federal Reserve. These institutions increase the money supply through repurchasing and fixed interest rates not out of malice, but to address unsustainable government deficits and deteriorating state solvency due to imbalanced public accounts. The central bank does not dictate fiscal policy; rather, it is the government that creates money out of thin air, passing the resulting imbalances onto citizens through inflation and taxes.
In an open economy, commercial banks do not create money arbitrarily; they lend to viable projects with collateral and expected returns. The notion of banks creating money without consequences arises when regulations disconnect rates from risk and allow the accumulation of government debt under the guise of being “risk-free.” This practice inevitably leads to inflation, financial crises, and economic stagnation. The excess money created is often misused, eroding the currency’s value, impoverishing citizens, and weakening small and medium-sized businesses.
The ECB’s potential interest rate cut in June may be premature and misguided. With rising money supply, persistent inflation, and an underlying trend of increased inflation levels, declaring victory over inflation seems premature. The ECB’s policy decisions have far-reaching consequences, impacting economic growth, risk accumulation, and overall stability.
While some attribute the eurozone’s economic stagnation to ECB rate hikes, negative interest rates have also played a significant role in this scenario. It is essential to recognize that sustained negative rates do not equate to genuine economic growth but rather signal the accumulation of toxic risks. Inflation, as a monetary phenomenon, is primarily driven by currency devaluation rather than external factors like “greedflation.” Understanding these dynamics is crucial for formulating effective monetary policies that promote economic stability and sustainable growth.
However, no central bank is willing to challenge a financial system that relies on the misconception that public debt is completely risk-free. Central banks understand that inflation is primarily a monetary issue, which is why they combat rising consumer prices by increasing interest rates and reducing the money supply. However, they tend to do so cautiously because governments often benefit from inflation.
The current problem with lowering interest rates, especially when there is no clear evidence of controlled inflation and when the currency’s purchasing power is already eroding by 2% annually, is that it perpetuates the narrative that the eurozone’s economic struggles are solely due to monetary policy. In reality, the root causes lie in flawed fiscal policies, the failure of initiatives like the Next Generation EU Funds, shortsighted industrial policies, and a taxation system that hinders innovation and technological advancement.
The ECB acknowledges that interest rates are relatively low and that the money supply has not decreased as anticipated. Despite this, the ECB continues to repurchase bonds and does not plan on significantly reducing its balance sheet until the year’s end. Lowering interest rates at this point carries the risk of devaluing the euro against the dollar, increasing the import bill for the eurozone, reducing reserve inflows, and further fueling public spending and government debt in countries like Italy and Spain, where inflation is also uncontrolled.
It is crucial to remember past mistakes, such as when Greece was seen as the EU’s growth engine or Germany as its “sick member.” The ECB cannot emulate the Bank of Japan due to fundamental differences in economic structures and the failures of Japan’s ultra-Keynesian approach.
Critics who blame the euro and the ECB for the eurozone’s weaknesses should consider the potential consequences of reverting to individual currencies and populist governments with unchecked printing powers. The region’s history of high inflation and destructive devaluations serve as a stark reminder of the pitfalls of such a scenario.
In conclusion, the eurozone’s challenges are not solely due to monetary policy but also stem from broader economic issues. It is essential to address these underlying problems to ensure the region’s long-term stability and growth.
*Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.*
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