September 26, 2019

Unconventional Monetary Policies Should be Met with Unconventional Fiscal Measures

The European Central Bank (ECB) proceeded with its unconventional monetary easing measures by cutting already negative key interest rates by another 10 basis points to -0.5 percent earlier this month. Further, the ECB announced it would restart the quantitative easing strategy, buying government bonds or other assets to inject liquidity into the economy, with a €20 billion purchase of bonds monthly beginning in November. These moves run counter to what was predicted a year ago. Then, the ECB was expected to raise rates late in 2019. Now, the lack of inflationary pressures and weakness in the eurozone economy, particularly with negative growth in Germany, the area’s anchor, prompted a further stimulus to their economies.

In normal circumstances, additional monetary easing in a weak economic environment is quite welcomed. However, with heavier usage of these unconventional policy tools, there is a growing trend now where more ECB board members are vocally questioning the effectiveness of these policies and concerns of the possible negative side effects. These members include the Dutch central bank President Klaas Knot (writing on their national bank’s website a day after the decision), Deutsche Bundesbank’s Jens Weidmann (expressing his dissent in the Bild newspaper), and French and Austrian central bankers.  

Indeed, the crux of the current sluggish growth among the eurozone countries is not necessarily a cyclical one, but more a structural one, where problems include the following:

  • The uncertain business and investment climate from global trade frictions and lack of resolutions likely to come any time soon.
  • The longer-term demographic trend of an aging population, where not enough younger workers or foreign immigrants are refilling the retiring labor force.
  • The huge income and asset gap between the rich and the poor, where rising asset prices may accentuate the gap further.
  • The flatness of the yield curve and low interest rate environment leading to weaker financial results in the European banking system and more cautious lending.

Hence, the recent ECB moves may not have an immediate impact in improving any of the above.

My View: The true resolution to fix these problems is fiscal policy, but unfortunately it is not happening quickly enough due to political disagreements. In my mind, monetary policy, including unconventional ones, is a means to simply ”buy time’’ before the real fiscal solutions kick in. The negative side effects of these unconventional policies exist but they may be less worse than letting the economy plunge into a deflationary environment (as we have seen in Japan, where central bankers hesitated and were too late in taking unconventional measures).

Despite the cacophony in the ECB on unconventional monetary tools, it is no surprise that all board members agree on the necessity of greater fiscal stimulus to fix these structural problems. On this front, governments can take advantage of negative rates to raise money by issuing negative interest rate bonds – another new normal that reduces concerns of governments’ future debt servicing levels. With possible negative side effects happening from unconventional monetary policy, the timing now has to be to counter them with bold, fiscal stimulus.

In conclusion, if the economy calls for unconventional monetary policy, politicians should realize the urge and need to actively execute unconventional fiscal policies simultaneously.

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