Harry Geels: Financial repression once again
This column was originally written in Dutch. This is an English translation.
By Harry Geels
The official policy interest rate is again lower than inflation for the main economy in Europe, which, incidentally, has been the case for the Netherlands for some time. It means impoverishment of savers and enrichment of debtors. There are also two salient details regarding current monetary policy.
Last week, the ECB cut the official policy rate for the fifth time in a row, to 2.75%. The ECB believes that inflation is moving toward the 2% target and that the economy in Europe - with Germany and France in particular moving around zero growth - needs to be stimulated. In doing so, the deposit rate comes in below inflation for Germany, for example. For just under two years, this interest rate in our neighboring country was above inflation. In the Netherlands, by the way, the policy interest rate has been below inflation for a long time, which was 3.3% for January.
Figure 1: ECB deposit rates lower than German inflation
Source: X/Holger Zschaepitz
Inflation higher than interest rates indicates a policy of financial repression. Here, central banks steer interest rates to lower levels to keep debts affordable and debts decrease in real terms. Debtors benefit and savers lose out. Potentially, investors in financed residential real estate are particularly benefiting. Real estate typically rises minimally in line with inflation, while mortgages decline in real terms. As has been said so often, monetary policy leads to large 'wealth transfers' in an economy.
The policy of financial repression is not new in Europe. Since the 2012 euro crisis, which was caused by the high debts of Italy and Greece, this policy has also been pursued. The previous president of the ECB, Mario Draghi, even brought official interest rates below zero for years, an unprecedented wealth transfer from savers to euro countries with large debts. It remains extraordinary that critics of the current system look mainly to 'the free market' as the cause of the problem of inequality, but fail to name or fathom the impact of monetary policy.
Situation US
A policy of financial repression is also pursued in the US, but much less vehemently than in Europe. The Fed has never brought the official policy rate below zero in recent decades. Only during the inflation spike caused by the Covid-19 lockdown policy was the policy rate significantly below inflation. It is interesting what the new Treasury Secretary, Scott Bessent, has in mind. His 3-3-3 plan (max 3% government deficit, 3 million additional barrels of oil per day and 3% economic growth) seems to be pushing for lower inflation.
That lower inflation is achieved by more oil, which leads to lower energy prices, and by a lower government deficit (now around 6.5%). Less government spending generally also means less inflation. If Bessent manages to keep real interest rates below 3% while economic growth is above 3%, government debt shrinks as a percentage of GDP. By the way, Donald Trump has said several times that he wants lower interest rates. It stimulates the economy and keeps interest rates on government debt affordable.
Central bank independence at stake
Officially, central banks are independent and should primarily control inflation. In doing so, the Fed has a dual mandate: in addition to inflation averaging 2%, maximum employment. The ECB has one main objective: to keep inflation around 2%. There is another sub-objective, which is to support the eurozone economy as long as it does not conflict with the inflation target. Through the informal circuit, however, political pressure on monetary policy is still being exerted.
Salient detail, just before the last ECB interest rate cut, was the meeting between EU President Ursula van der Leyen and ECB President Christine Lagarde. There is open speculation of political interference. Lower interest rates would be needed because of slow growth in large parts of the euro zone and high debt, while inflation is still too high in several countries. The question is also whether such lower interest rates would help at all. The slowdown in growth is mainly due to the poor competitiveness of European industry versus that of the U.S. and China.
Savings rate too low for years
As if a policy of financial repression for savers were not bad enough, most banks have been paying even lower savings rates to their customers. That is, significantly lower than the official policy rate, with the banks complicit in the wealth transfer from savers to debtors and indirectly to the banks' shareholders. I have been puzzled by low savings rates for years, because savings are effectively a loan to the bank, which then lends the money with leverage at (much) higher interest rates.
Saving has been a losing game for years because of inflationary policies and low bank fees. Therefore, we should not be surprised that people engage in other activities with their money, such as investing in real estate, stocks, gold and crypto currencies. 'Asset inflation' is ingrained in our financial-monetary system. When a bank creates money through 'fractional banking' to let someone buy a house with it, for example, newly created money is used to buy assets with limited availability. See here another (mostly unnamed) source of inequality.
This article contains a personal opinion of Harry Geels