From “Dividing by Zero” (Global Knowledge, 2016-2017), Ana Nives Radovic
Last month’s decision of the European Central Bank to keep interest rates in Eurozone under their historical minimum, with the key reference rate at zero, as well as to leave their substantial public and private debts accumulated since 2015 operational was followed by this institution’s decision to leave the marginal lending rate at 0.25 percent, allowing banks to borrow for 24 hours.
There has been stated that with zero interest rates banks will be capable to fund themselves at no cost from the ECB, and should consequently lower the rates they apply to their customers who owe them. The low down rates of the ECB have an automatic influence on the short-term savings, since a bank cannot have enough money to pay cash at a high level, and thus since it cannot lend at a good price, because it would lower its margin. The ECB disclosed a set of monetary policy procedures, counting a turn down in its central rate to zero for the first time in its history, adding a new oversized long-term loan for banks, where the first part of the plan has continued its realization relatively as intended, considering that, since the ECB took out its financial plan, savings of citizens across the Eurozone have witnessed how the average salaries declined.
This means that if the ECB decreases its interest rate, it wants to promote credit activities and therefore enhance investment. Increasing it in this case means that there is a visible threat of inflation, since too much money is in cash flows, while prices are rising rapidly, so there is a need to be in charge of the situation. In a situation as such, political risk is one of the main challenges for this year and the ECB authorities are fully aware of that, so they are willing do everything they could to prevent market disorder, even though their action might make the situation worsen. There should not be any new proclamations of new decisions related to interest rates, though this is the beginning of monetary contraction that seems untimely if it happens sooner than key elections in several countries, alongside a conditions of increasing populist movements, so the ECB is not willing to witness additional uncertainties.
As ECB invested in very short-term products, it is the capital that is mostly affected by the zero rates, particularly commercial paper issued by corporations. By longstanding stagnation, there should be understood a situation of fragile growth marked for long by near to the ground and even zero interest rates. A recovery of growth and inflation is in progress, since the demand deficit is not unavoidable and since the additional savings are expected to overturn, efficiency is supposed to raise. Therefore the ECB has decided to initiate a wide-ranging asset purchase program, which has drawn together, but also surpassed the previously announced programs. The program of Quantitative Easing, which started in March 2015, consisted of purchases of private and public bond securities on the secondary market for a amount of 60 billion euros every month and has been decided due to the collapse of inflation and the risks of deflation to the Eurozone. Added to this, zero rates and especially the negative rates are a symbol of nonsense, since the zero point in a range of values sends the message that there are no other points.
Overnight deposit rates that were found in the negative area for the first time in June 2014 were maintained at -0.4% and they were strengthened last month, passing from -0.3% to -0.4%. A negative rate is supposed to support banks not to leave this money for the central bank but to loan it to their clients, which means that banks have to pay a fee to the ECB for surplus cash for 24 hours. There are big differences in assets between a rate that goes from one to five percent, measured up to to those that would go from zero to one percent, since zero point is mainly due to the fact that dividing any number by zero is not possible. In practical translation, a rate of 0% allows an economic agent to borrow in theory an unlimited sum with a zero cost. Zero point suggests the perception of unwarranted action, increasing to a substantial psychological aspect visible in investors’ behavior. The turn down in borrowing rates used by the state has a straight collision with the income from funds on life insurance contracts, which are still mainly composed of government bonds.
At these times, when the outcome is round after a while as insurance companies maintain debt securities acquired several years ago higher than debt issued, the ECB introduced the scheme where the threat becomes zero or unreal and where the time value is zero. However, time has a value, shown through scoring, distance and having lack of it. The depository banks also increase its debt repurchase volume from 20 billion euros per month to 80 billion, extending the possibility of qualified securities for these procedures. There are no visible proofs that the aims of the ECB are really there, whether inflation, targeted at the rate of two percent, or economic growth in the Eurozone, which is an economic oddity that has never been explained in economic theory. At the same time the ECB was strengthening its comprehensive debt exchange program and for two years of its presence it has distributed 1,740 billion euros, so the range of securities entitled for debt repurchase has been comprehensive to consist of bonds issued by corporations in the Eurozone, apart from banks.
There was seen the recent rise in prices that is mainly owed to the rise in oil prices, which were noticeably lower at the beginning of last year, and to a boost in food prices, especially fruits and vegetables, caused by a very harsh winter in southern European countries. Taking unpredictable elements into account, such as inflation generated by wage increases will prevent it to remain too near to the ground to give explanation for any monetary contraction, though as often, the common sense of every decision-making reminds us that when a strategy does not work, it is because the institutions have not done enough. The securities purchased through the QE program may have a maturity of up to thirty years, which will be arranged under a rule of proportionality to the involvement of each government in the ECB scheme. Securities purchasing practice should not provoke governments to budget lack of discipline, since all the procedures announced last month go beyond the potential of the markets, which were only waiting for a boost in the repurchases of debts and a decline of one of the deposit rate. It is comprehensible that in this procedure the liquidity increased by 1000 of cash in order to carry on playing, the banks recovered their positions completely and the ECB recovers the decomposed risk and the risk of default, so clearly this is how billions of euros are being created fictiously. In substitute for the debt in custody by various banks, ECB simply credits its bank account of 1000, just by notional inscription of 1000 more.
This is the situation where no more than these type of investments are supposed to be made, hypothetically, of adjustable monetary policy, so it has generated an incursion of ready money placed in various shares. Somewhat approximating to the fiscal deficits, that are supposed to enhance growth, when there was no visible growth, the shortages were not high as much as necessary, which is similar to the refinancing rate, in the sense that it applies when a bank requires liquidity, though these loans are on a daily basis and have to be repaid for the next day, different from the refinancing rate, which is weekly.
The ECB has managed the purchases of securities within the limits specified by central banks of Eurozone members so that the risk taking was covered 20 percent by the ECB in the structure of a cohesion principle, while the rest was under the responsibility of each central bank. Projected low rates were supposed to encourage investments that were planned to stimulate growth based on positive action of businesses and consequently their stock market appraisal. For the first time in four years, inflation in February reached the targeted rate of two percent, exceeding the ECB’s target of a slightly lower price boost, while at the same time economy of Eurozone has shown certain signs of strengthening. A crossroad in the ECB’s point is not to be anticipated before the meeting expected in June, which is enough time for opponents of current ECB’s policy to come up with different solution that would stimulate lending, investments and growth rather than zero rates that make fictive results.