18 May 2015

ECB: Occasional paper - Critique of accommodating central bank policies and the 'expropriation of the saver'

European Central Bank's aim is to show that the argument that central banks’ low nominal interest rate policies expropriate the saver is flawed. Eventually, real rates of return on savings depend on growth dynamics and the associated real rate of return on capital investments.

Monetary policy cannot manipulate this rate of return to the upside in a structural manner. It may be able to do so temporarily, say for one or two years. But this is not a horizon relevant to the saver, and beyond the short-term horizon, any attempt by the central bank to artificially increase real rates of return through monetary policy will back fire and harm, instead of helping, the saver. In any case, the mandate of the ECB is unambiguous, in the sense that it is the ECB’s primary objective to maintain price stability. Everything else is to be deduced from this overriding objective which is enshrined in the European Treaty.

If the ECB became convinced that short-term real rates of return on money investments were themselves an objective and, for that sake, tolerated excessively low inflation for too long (or even deflation), this would amount to a very problematic deviation from (and in the worst case clear violation of ) its primary objective. Price stability is the benchmark against which all other risks and potentially problematic side effects (as discussed) of policies at the ZLB need to be assessed.

To adopt a certain wait-and-see attitude, hoping for a benign turnaround of the inflation outlook, may be appropriate for a short period of time (and covered by the medium-term qualification of the ECB’s mandate), but certainly not forever. At some point the ECB has to act forcefully to defend its objective. Given the mandate that has been entrusted to the ECB, it is not an option to systematically deviate from the primary objective. The ECB does not have the democratic legitimacy to change, by itself, the mandate it has been assigned in accordance with the EU Treaty. The ordering of the ECB’s objectives has to remain lexicographic, with financial stability concerns secondary to monetary policy objectives (Smets, 2014). Financial stability concerns must be addressed primarily through financial regulation, including macro-prudential policies.

The only situation in which a central bank should refrain from adopting low interest rate policies despite excessively low inflation rates and despite being close to the zero lower bound, is if low interest rate policies have been proven to be ineffective or even counterproductive with regard to the objective of restoring an inflation rate that is closer to the desired, higher level. The paper therefore also reviewed a number of arguments that critics have put forward to substantiate such a claim.

The paper also reviewed the various explanations for the steady decline in the real rate of interest in the last three decades: structural factors like the slow-down in technological innovation and population growth, labour market sclerosis and barriers to competition, fiscal factors like austerity measures that increase loanable funds or the regulation of financial institutions and the resulting increase in the demand for safe assets, and the current age pyramid that forces baby boomers into high rates of saving.

Full paper

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