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Keynote speech by Mario Draghi, President of the ECB, at the Deutsche Börse Group New Year’s reception 2016, Eschborn
Overall, it’s clear that the impact of the APP on confidence, credit and the economy has been substantial.
Certainly, in the short run, a fall in inflation helps consumers. But if inflation stays too low for too long it actually harms them. And that’s particularly the case in a post-debt crisis environment like the one we face in the euro area today.
Very low inflation complicates the adjustment process within countries, leading to higher unemployment. It delays the rebalancing process across countries, hindering those that lost competitiveness prior to the crisis from regaining it. And if low inflation is unexpected, it raises real debt burdens making it harder for the economy to grow out of debt.
Questions about the ECB’s policy
Let me discuss what I see as the three main issues.
The first is the perception that low interest rates unfairly punish savers. Low interest rates of course lead to lower returns on safe assets, such as deposits. But what matters for savers is what their assets can actually buy – i.e. real returns – and how their overall portfolios are performing. And it turns out that on this metric, the situation isn’t nearly as bad as it’s often thought to be.
A related concern is that low interest rates cause people to save more to make up the difference and are therefore self-defeating. But that’s also not quite right.
What low interest rates are doing, however, is stimulating the economy and especially the demand for durable goods, like cars. That supports the recovery, boosts incomes and will ultimately lead us back to normalisation more quickly. If, on the other hand, we were to raise rates today, the opposite would happen. It would simply push us back into recession and rates would stay lower for longer.
The second concern about our policy is that it threatens financial stability. Low interest rates, it’s said, discourage balance sheet repair and create “zombie banks”. It’s also claimed that they encourage excessive risk-taking, leading to bubbles. And the longer they last, the worse the risks get.
These are doubtless important issues – but is it really the task of monetary policy to react to them?
After all, as far as policymaking is concerned, what matters for the health of banks is not the level of interest rates, but the quality of supervision. And thanks to the creation of the Single Supervisory Mechanism (SSM) and the comprehensive assessment of banks’ balance sheets, banks are actually stronger now than they were a few years ago. Capital ratios for euro area banks have risen from around 8% in 2007 to close to 14% today. In other words, the risks are currently falling, not rising.
What’s more, though low interest rates can encourage risk-taking, there are no warning signs of serious financial instability.
The third concern about our policy is that it takes the pressure off governments to pursue structural reforms. But there are several problems with this argument.
In fact, what typically happens when interest rates are high is not long-term reforms, but rather short-term fixes to placate the markets. And that normally means consolidating budgets by raising taxes, which makes the recession worse. That in turn creates an even harder environment for structural reforms as the costs are higher in a depressed economy.
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A third area is dealing with the high levels of public and private debt which are casting a shadow over the recovery. Part of the solution is to have well-designed corporate insolvency regimes that can separate viable from non-viable borrowers and facilitate the valuation of assets to be sold off. But it’s also key for confidence that the bank resolution process is absolutely clear.
In particular, we need to make sure that the new bail-in rules are applied evenly across countries and with the minimum scope for national discretions. We also still don’t have agreement on a backstop for the Single Resolution Fund. And a European deposit insurance scheme would signal progress in completing banking union.
That brings me to the final area for action: completing our monetary union. The Five Presidents’ Report has laid out a long-term vision for Economic and Monetary Union (EMU) and a sequence of steps towards it. Now we need to realise the short-term steps that will lend credibility to that long-term vision – first and foremost, by finishing all three pillars of banking union.
Removing the fragility of EMU, by making progress with both the short-term steps and the long-term vision, would bring about a vital boost to confidence in Europe.