News | Wednesday, 10 June 2009

Implications of a one per cent threshold

Last Thursday, the Governing Council of the European Central Bank (ECB), after three months of successive cuts, decided to keep the base rate at 1 per cent. CHARLOT ZAHRA asks two economists – John A. Consiglio and Karm Farrugia – about the implications of this decision on the eurozone economy, which is passing through a tough recession, and whether the use of non-standard measures to stimulate economic growth by the ECB was still a possibility

John A. Consiglio: “Tinkering around with the interest will not have any further effect”

Sooner or later, an economic conjuncture changes, and the decisions of central banks, or other decision makers, will necessarily have to also change from some previously seen patterns.
All through these recent periods I have been saying that there is some point at which the European Central Bank (ECB) will start feeling that more tinkering around with its intervention rate will not have any further effect in a desired direction.
As I said over past weeks, interest rates are not the only determinants of economic conditions, and when other factors – for instance, export orders beginning to improve, financial market protagonists returning to trust amongst themselves, effects of State help measures beginning to seep through into key desired sectors, etc – start suggesting some sort of “early green shoots” evidence, then one should not be surprised that the ECB slows down from a previous followed path, and either holds horses for a spell, or even then possibly changing it.
Because these ‘early shoots’ are, at this stage, by no means consistent all over the euro zone, then certainly the ECB is correct to just mark time, that is, for the moment follow a ‘no change’ policy action.
It might – or then it even might not – shift if, for example, the capital markets embark on a more continuous rise pattern, or if it sees that job markets have taken a permanent shift towards the better, or if social security and tax rates for all governments in the euro zone again start returning to a consistent upward climb.
But all of this is, for the moment, nowhere near yet, and so these elements, plus others, unsurprisingly continue to push the ECB towards caution.
At times like these, Central Bankers – ever cautious and prudent – normally stop to survey not only the economic scenario around them, but also their available array of intervention tools, and whether it is worth “trying” non-standard measures at all.
It is possible to conceive their considering the stance of: “If governments’ medicine is bringing about positive change, then should we intervene with for instance: more open market operations?”
The threat of inflation does not, at this point in time, loom as the euro zone’s greatest pan-zone threat.
At this point in time the recession drags on yes, but there are already certain very noticeable differences between countries as to what place on the bottom part of the U-curve they respectively stand.
My belief is that when we’ll get towards the last quarter of this year there will be even wider differences between euro zone countries as to where they stand on the curve.
That of course will be an even more interesting period to watch …and remember, around that time of the year Malta too normally has its annual budget being presented.... as the Chinese course goes, we live in interesting times.

Karm Farrugia: “The ECB should have cut the rate even further down to 0.5 per cent”

What is your opinion about the ECB’s decision not to cut interest rates and keep them at a historical low of 1.00 per cent?
The European Central Bank (ECB) could have cut the rate even further down to 0.5 per cent. But that’s how Trichet and company think, probably this time not so much for fear of inflation, but much more likely for fear of deflation.
The ECB appears to believe that even at 0.5 per cent the rate would dissuade people and businessmen from spending, in the expectation of a negative inflation – deflation – but still they would rather leave their savings at home than deposit them with banks. Estonia is a case in point.

What will lead the ECB to lower the interest rates lower than 1 per cent?
Nothing – they are monetarists through and through – look at the way they still insist on the 3 per cent ceiling of public deficit to GDP, as if the world – and Europe, in particular – is only facing a normal business/trade cycle or a mild recession.
Do you think that the ECB will eventually have to resort to “non-standard” measures to support the Euro zone economy? Why?
Yes, I do, but not immediately and only if the trough of the recession is still not reached inside another 3 months. My view is, yes, the time is ripe already, but then I hardly ever see eye to eye with central bankers of the ECB type.
To “stoke” inflation, you must first have it, though not the type of inflation we are experiencing in Malta which is due to abuses by players in insufficiently-competitive markets.

In view of the latest economic data for the euro zone, when do you think that the euro zone will start coming out of the economic recession? Will it be a protracted recession or a short one?
Hard to predict. However, it will be later than, say, for the US and other non-euro zone economies in the EU.
The current recession can never be described as “short” no matter what happens in the course of this year and next.
We have yet to feel that it has bottomed out. Only when this is reached can one comfortably predict its length of time before ascendancy.



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10 June 2009

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