Who still believes in the competence of central banks?

02 sep. 2019 English Section
Călin Rechea (translated by Cosmin Ghidoveanu)

Lately, it seems that not a day goes by without the international press pointing out the inability of the central banks before the adverse dynamic of the real economies worldwide and the increased volatility on the international markets.

As if that wasn't enough, the nice story that the central banks have built since the beginning of the global financial crisis is also being undermined by the conclusions of an increasing number of academic studies on the effects of negative interest rates.

Their introduction, despite the fact that the notion of "negative interest rate" is absurd from an economic point of view, was justified through the need to stimulate lending and fight deflation.

Unfortunately for the central bankers, it seems that negative interest rates do not stimulate lending, according to a recent study published in "Journal of Financial Services Research" under the title "Did Negative Interest Rates Improve Bank Lending?" (july 2019).

Based on data collected from 6,558 banks in 33 OECD (Organisation for Economic Co-operation and Development) member countries, the authors have found that "after the introduction of negative interest rates, bank lending was weaker in countries that have adopted this measure of monetary policy". Negative policy rates have been introduced by the central banks of Sweden, Switzerland, Japan, Denmark, and the Central European Bank.

Moreover, "the adverse effects of the negative interest rates are more heavily felt on the smaller, lower capitalized banks, which depend on retail deposits for funding and operate on more competitive markets".

Nowhere in the article have the authors said that the results of the study are an absolute truth. They couldn't even have done that, the absolute truth is the monopoly of central banks.

Nevertheless, the analysis represents "a good example of unexpected consequences", as stated by one of the authors, professor Ru Xie, of Bath University of Great Britain, in a press release on the website of the institution.

"Our study shows that the policy of negative interest rates has an adverse effect, especially in an environment in which bank profitability is already low, the economic turnaround is long in coming, and there is a high level of non-performing loans", professor Xie further said.

The conclusion is valid both for the total loan volume, as well as for the components represented by mortgage loans or by the loans granted to financial companies.

But that is not all. Aside from the ineffectiveness of negative interest rates in stimulating lending, they also "seem to cancel out the impact of other non-convention programs of monetary policy, such as quantitative easing", as stated by professor Ru Xie.

We have to admit that "that performance" is really something and it should give people pause about the true level of competence among central banks regarding the "modeling" of economic reality.

A good example in that regard has been offered by an economist of the Federal Reserve Bank of Kansas City, who, after showing that "the negative nominal interest rates can worsen the liquidity trap", and comes with a mind-boggling "solution" regarding the nominal interest rate needed to eliminate such a situation. It should fall below -100% (author's note: yes, you read that right!), because "the negative nominal interest rates cause the real economy to contract ina a situation of liquidity trap".

According to the definition from Investopedia, "the liquidity trap is the situation where the interest rates are low, and the savings rate is high, which leads to the ineffectiveness of the monetary policy".

In other words, "the answer to the deflation problem is the erasure of the value of money by the central bank within less than a year since they have been made", according to the analysts of Cantillon Consulting.

Unfortunately, this kind of "solutions" show that the problems that are facing the central banks are not just economic, but have long entered the realm of mental health.

Similar conclusions on the ineffectiveness of negative interest rates have appeared in the article "Negative Nominal Interest Rates and the Bank Lending Channel", published on the website of the NBER (National Bureau of Economic Research) in January 2019.

Based on an extended set of data from the Swedish banking sector, authors have noticed that "in the case of a negative policy rate, the mechanism for transmitting the monetary policy through the banking system is no longer working".

Moreover, "a negative interest rate is at best, irrelevant, but it can have a contraction effect on the production in the real economy due to the negative effects on the banking profit", according to the authors' conclusion, who include Lawrence Summers, professor at Harvard and former secretary of the US Treasury.

As for the effect of negative interest rates on deflation, an article recently published by two economists from the Federal Reserve Bank of San Francisco (author's note: "Negative Interest Rates and Inflation Expectations in Japan", FRBSF Economic Letter, August 26, 2019) shows that "despite the economists' expectations, the negative interest rates in Japan have led to the drop in inflationary expectations in the medium and long term, rather than causing them to rise", meaning the negative interest rates haven't even "solved" the problem of deflation.

All of the above are just insignificant details to Christine Lagarde. The future president of the ECB doesn't know these studies, according to her statements sent to the European Parliament in the hearings for "selecting" the replacement of Mario Draghi.

"On one hand, banks can shift the negative interest rates to consumers, by reducing interest income, but on the other hand those customers are also consumers, workers or debtors, thus they will benefit from a stronger economic turnaround", says Mrs. Lagarde in the document posted at the end of last month.

The future leader of the ECB seems to be just as ignorant when it comes to the profitability of the banking system in the Eurozone.

What else is there left to do, given that the time is quickly approaching when the true "new clothes" of the central banks will be visible to everyone?

Let's hope that nothing of what Ewald Nowotny has suggested, whose term at the helm of Bank of Austria has ended, after 11 years, on August 31st, 2019.

In one last interview as governor of the central bank, Nowotny told Wiener Zeitung, that "the luck of having 74 years of peace has led inevitably to the accumulation of an extraordinary wealth on one hand and to a similar volume of debt, on the other hand".

The conclusions of the interview were reported by Bloomberg with the title "Nowotny says that 74 years of peace have imbalance the economy". The former governor of the Bank of Austria has also pointed our that "wars or high inflation have resolved that problem in the past", but "how we are going to fix the problem without these factors, it remains to be seen".

Why aren't the cuckoos' nests guarded better, to prevent lunatics from flying off to become high ranking executives in central banks?

Opinia cititorului

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