European Central Bank (ECB) President Mario Draghi at at Deutscher Bundestag, Berlin, 28 September 2016

posted in: Monetary Policy, Notes | 0

A 0% target inflation is not good for the economy

“Sometimes people wonder whether price stability doesn’t mean inflation of 0%. It does not, because both inflation that is too high and inflation that is too low for too long can damage the economy. A steady, measured rate of inflation below, but close to, 2% in the medium term acts like a cushion that protects our economies from drifting into the dangerous territory of negative inflation even when there is just a minor economic shock.”

The measures to boost the inflation rate have been successful

“Our measures have delivered. We estimate that they will raise the inflation rate by more than half a percentage point, on average, over 2016 and 2017. They will also contribute to increasing real euro area GDP growth by more than one and a half percentage points cumulatively between 2015 and 2018, which will support job creation.”

Low rates reflect the slump in economic growth

“Low rates are a symptom of the underlying economic situation. They reflect weak long-term growth trends and the protracted macroeconomic slump that has resulted from the crisis. ”

Efforts bearing fruit

“Through our efforts to bring inflation back towards 2%, we have contributed to higher growth and the creation of more jobs. In Germany, exports are benefitting from the recovery in the euro area, unemployment is at its lowest level since reunification, people’s take-home pay is increasing noticeably, and venture capital is pouring into Berlin’s silicon alley.”

Lose here, gain there

“What a household may lose in terms of little interest on their bank account, it might save in lower mortgage payments for their home. And it might benefit from rising bond and stock prices in their retirement fund. In fact, evidence shows that between 2008 and 2015 interest payments by households in Germany, as a percentage of gross disposable income, fell more sharply than interest earnings.”

The ECB is not solely to blame for low bank profitability

“The ECB’s monetary policy is not the main factor for the low profitability of banks. While some banks’ business models may indeed need to adapt to the current low interest rate environment, they also need to address their own structural issues, such as overcapacity, the stock of non-performing loans and the potential impact of technological innovation. Low profitability is closely linked to low operational efficiency.”

The Euro area is not overheating.

“Of course, low interest rates for a long period might carry the risk of overvaluation in asset markets as a result of the search for yield. This is why we closely monitor potential risks to financial stability that might emanate for instance from local real estate markets. But at the moment we are not seeing any overheating in the euro area or the German economy as a whole.”

Real interest rates depend on the long term growth prospects of the economy

“It should also be noted that the level to which real interest rates can eventually return when the economy strengthens is not determined by monetary policy. Instead, it depends on the economy’s long-term growth prospects. Productivity and demographics play a decisive role in this, and the development of these factors has not been favourable in Europe in recent years.”