Since March 2016, the main refinancing interest rate of European Central Bank (EZB) is zero, and since June 2014 the ECB’s deposit interest rate is in negative territory; it currently stands at –0.40 percent. This means that euro area banks get zero funding from the ECB, and that they are charged a fee on excess reserves they hold with the central bank. The ECB’s unprecedented lowering of interest rates flowing the crisis 2008/2009 was accompanied by a huge bond purchasing program (through which the base money supply was ramped up by close to 2.8 trillion euro), and euro area banks were also offered additional term-credit at most favourable interest rates.
On 18 June 2019 ECB president Mario Draghi indicated that a new round of monetary easing is around the corner. In view of the US Federal Reserve’s now openly voiced bias towards easing monetary policy in the coming months, the ECB Governing Council can be expected to feel emboldened to go ahead with its plan. Keynesian minded observers surely stand ready for applause. They think that by lowering interest rates, by bringing them even into negative territory, the euro area economies would be kick-started, benefitting output and employment. This, however, is a serious mistake.
A sound understanding of the interest rate phenomenon reveals that the ECB’s attempt to push market interest rates to ever lower levels, and ultimately into negative territory, is economically highly destructive. For the ECB’s meddling with credit markets pushes the market interest rate below the level that would prevail had the ECB abstained from intervening in the credit market. The artificially lowered market interest rate triggers a boom, but only because it distorts peoples’ consumption, saving and investment decisions. This, in turn, leads to misallocation of scarce resources, and the initial boom will eventually end in a bust.
The ECB seems to be about to push yields on all euro area government bonds to zero or make them negative, largely by guiding investors’ future interest rate expectations downward. For instance, German government bonds with a 10 year maturity yield minus 0.32 per cent; the 2 year notes minus 0.76 per cent; and after Mr Draghi made his remarks, the French government benchmark 10 year bond yield turned negative for the first time ever. In other words: The ECB seems ready to rig the capital market for providing euro area governments with the opportunity to fund themselves at negative yields. The ‘new euro area credit market reality’ is that lenders pay when loaning to government borrowers.
Sound interest rate theory informs us that the ECB’s money policy is actually an outright attack on what little is left of the free market economic system. To understand this, one has realize that peoples’ time preference is always and everywhere positive, that it cannot fall to zero, let along become negative. Time preference means that people value a present good more highly than the good (of the same quality) available at a later point in time. The manifestation of peoples’ time preference is the originary interest rate. It stands for the value discount future goods suffer vis-à-vis present goods. Like time preference, the originary cannot fall to zero, let along become negative.
This is a (praxeo-)logical necessity, it is a category of the logic of human action. One cannot contradict the statement ‘ time preference and the originary interest are always and everywhere positive ‘ without causing a logical contradiction. Having said that, one can now easily conceive what happens if the ECB pushes all market interest rates and eventually all returns on investment to zero or even lower, while peoples’ originary interest remains positive: It would mean that people stop saving and investing, that they would consume their income in full. In other words: Capital consumption sets in, he division of labour collapses, people fall back into a primitive subsistence economy; and the death knell for millions and millions of people starts ringing.
Unfortunately, such alarmism is warranted: The ECB will most likely not restrict its efforts to bring down yields on euro area government bonds. It may also resume buying corporate debt and replacing banks’ capital market funding with direct credit lines to banks (by way of “TLTROs”). As all these yields fall, investors will increasingly search for yield. They will bid up prices for, say, stocks, houses and real estate, thereby compressing these assets’ future returns, pushing them towards the ECB’s artificially suppressed interest rate levels. The extreme end point of all this is the destruction of all positive yields, and this would mark the end of the free market as we know it today. But will it really become that bad?
One may hope it won’t. But we should not pull the wool over our eyes: Sound economic theory provides us with a clear understanding that the ECB’s monetary policy is working towards a bad end; and that there is unfortunately no indication that the ECB might abandon its devastating policy anytime soon. The loss of the free market system – as it is implied when market interest rates are pushed towards zero or into negative territory – would be a terrible price people are made to pay for upholding the euro. It is high time to stand up for those who really wish to preserve the free market system and thus individual liberty and freedom in Europe.
