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| The causes of monetary policy measures and their impact – a review |
| ECB, 19.11.2016 |
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| Speech by Yves Mersch, Member of the Executive Board of the ECB,
at the Euro Finance Week, FAROS Institutional Investors Forum,
Frankfurt, 17 November 2016
“The knowledge of causes produces a knowledge of effects.” (Marcus Tullius Cicero: “Cognitionem causarum enim cognitio eventorum facit.” Topica 67)
The financial sector is facing an upheaval. Many of the changes are intentional and positive. But certainly not all of them. And to understand the individual factors and their interactions better, I’ll be taking a closer look today at the causes of our monetary policy measures and their effects. For the European Central Bank’s policy is often referred to as a cause of the current problems in the banking and financial sector. It will quickly become clear that this assumption has its shortcomings. By focusing on the causes of our actions we can understand more easily how to get back to a normalisation of monetary policy.
Causes: Low Natural Interest Rates
Let us start with the causes. Why are interest rates so low?
The growth trend has been declining in many mature economies not just since the crisis, but for several decades. There are many reasons for this, which I won’t consider here in detail. The fact is, the slowdown in growth has led to lower long-term interest rates.
In these circumstances, there is a risk of a self-reinforcing downward spiral as these developments do not go unnoticed by economic actors; their expectations are worsening. If a company expects demand to fall, it will be less inclined to make big investments.
Moreover, ageing societies, which exist in many mature economies, not only have to cope with a shrinking labour force, but they also have to save more. This has led to a savings glut and to a shortage of safe assets. So investments are falling and savings are rising. This reluctance to invest is further reinforced when public authorities – with room to manoeuvre as well as existing demand - invest less than is needed even to preserve the capital stock.
This dynamic has led to a reduction in the natural interest rate, i.e. the real rate of interest in which savings and investments are in equilibrium in an economy operating at its potential, where there is neither upward nor downward pressure on inflation.
The natural rate of interest plays an important role in our monetary policy. If the key interest rate is below the natural rate, monetary policy has a stimulating effect on the economy as it encourages consumption and investment. Conversely, when the key rates are above the natural rate, this dampens demand and thus price rises.
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