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News | Wednesday, 11 February 2009

Economists disagree on ECB decision not to cut interest rates further

Charlot Zahra

A panel of economists interviewed by Business Today had differing opinions about the European Central Bank (ECB)’s decision not to cut interest rates further and keep the base rate at 2 per cent for February.
In the ECB council meeting held in Frankfurt last Thursday.
In announcing the ECB council decision on 5 February 2009, ECB President Jean-Claude Trichet explained that as anticipated in its interest rate decision of 15 January 2009, “the latest economic data and survey information confirm that the euro area and its major trading partners are undergoing an extended period of significant economic downturn, and that accordingly both external and domestic inflationary pressures are diminishing.
“We continue to expect inflation rates in the euro area to be in line with price stability over the policy-relevant medium-term horizon, thereby supporting the purchasing power of euro area households,” he added.
Since last October, the ECB had cut its base rate by a total of 2.25 per cent in a series of consecutive cuts.
Senior economist and Labour candidate for the EP elections Edward Scicluna disagreed with the ECB decision when asked about the matter by Business Today.
“As a euro zone we are in the midst of the recession and as such we need to throw everything at the beast to keep it from making more harmful advances,” Scicluna said.
“For this reason, I would agree with many other international economists and show my disappointment at the seemingly ECB’s inaction,” he told Business Today.
Asked what had led to this decision despite the fact that the annual inflation rate for the euro zone fell to 1.1 per cent last month, much lower than the ECB’s forecast of less than 2 per cent, the senior economist explained that when an economist found himself in a position that his economic instruments were not having the desired effect, one faced a dilemma.
“Should you conserve what you have or continue using what is left with the clear indication there finally you will run out of them?” he asked.
This was “not unlike” being on a sinking boat and trying to fire a number of flares. “When you come down to the last two flares, you have to make a big decision. Many a sailor in this predicament might opt not to fire the flare and conserve it. This is the situation the ECB is in at the moment,” Scicluna told Business Today.
On the issue whether successive interest rate cuts had failed as an instrument of monetary policy in fostering economic growth and consumer demand in the euro zone in times of deep economic recession or not, Scicluna said that they have not.
“You can take a horse to the water but you cannot make it drink,” he told Business Today.
“The central banks are ensuring that banks become flush with money. But there is no appetite whatsoever from the consumer side to buy. They are too scared to do that.
“Monetary policy has not been effective in these special circumstances of universal fear,” Scicluna insisted.
However, former Labour Finance Minster and economist Lino Spiteri agreed with the ECB’s decision to hold steady its base rate at 2 per cent this time around.
“I think the ECB is testing the ground to see if interest rate cuts are working. It wouldn’t wish to use up all its ammunition. I agree with the pause for reflection,” Spiteri told Business Today.
Asked what had led the ECB not to cut the interest rates in February despite the low annual inflation rate for the euro zone registered last month, Spiteri said telegraphically that “the answer to question one still holds”.
On the issue of whether successive interest rate cuts have failed as an instrument of monetary policy in fostering economic growth and consumer demand in the euro zone in times of deep economic recession or not, Spiteri disagreed with the notion that interest cuts stimulate growth or consumer spending.
“We are in times of great uncertainty. Interest cuts may stimulate neither new investment nor consumer spending. It is truly a time to reflect and analyse. That’s what the ECB is doing,” Spiteri told Business Today.
“Pushing interest rates close to zero is not the best way forward. Confidence needs to be restored. And excessive use of monetary policy could have an opposite effect,” the former Labour Finance Minister warned.
Veteran economist Karm Farrugia, when asked by Business Today about the ECB’ latest decision, was also critical of this decision. “As I have already had the opportunity to tell you, I had expected the ECB to follow its latest cut in interest rate with a further cut last week or this one. It hasn’t, and decided to stay put for at least another month,” he lamented.
He accused the ECB of being “not in tune with the rest of the world, and refuses to listen despite having its zone aggregately in recession and soon completely, Malta included – I fear, though I hope to be wrong”.
Farrugia was equally scathing when asked to comment about what had led to the ECB’ decision despite the low inflation figures of the euro zone for the previous month.
“The ECB governors are of the ultra-conservative ilk – always the last to move and only when they cannot do otherwise,” the veteran economist charged.
By contrast, the Bank of England on the same day reduced its rate by 50 points, Farrugia added.
The veteran economist agreed with the view that successive interest rate cuts had failed as an instrument of monetary policy in fostering economic growth and consumer demand in the eurozone in times of deep economic recession.
“Interest rate cuts have not had any visible effects on recessionary forces, hence monetary tools alone cannot cope with the intensity of the downturn,” Farrugia told Business Today.
“Fiscal and other stimulants – God forbid if they will also include protectionist measures – are overtly essential, but they cannot function without interest rate reductions on the scale witnessed until now, perhaps even more until the rate is a little above zero for fear of a deflation onset which could be as bad as the recession which will have preceded it,” the veteran economist warned.
Finally, economist Lawrence Zammit was in agreement with the ECB’s decision when asked by Business Today about the matter.
“Yes I definitely agree,” Zammit said. “What we need is not further interest rate cuts but efforts at improving business and consumer confidence.”
Asked for his views on what had led the ECB not to cut the interest rates this time around despite the low inflation rate registered in January 2009, Zammit said that the ECB “also needs to make sure that it does not make money so cheap that it fuels inflation through a very low interest rate.
“I think this issue weighed heavily on the minds of the ECB,” Zammit told Business Today.
Finally, regarding the issue of the effectiveness or not of successive interest rate cuts as an instrument of monetary policy in fostering economic growth and consumer demand in the euro zone in times of deep economic recession, Zammit said that “interest rate cuts on their own are not enough, at any point in time, not just in a recession. Business and consumer decisions are also based on the prevailing sentiment,” he told Business Today.
“Moreover, markets in unusual times do not always act rationally and efficiently, as some have led us to believe,” Zammit warned.

czahra@mediatoday.com.mt

 

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11 February 2009
ISSUE NO. 569

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