Even with inflation at 5%, some people believe that higher interest rates will crash the economy. Is this 2011 all over again1?
As I explained on Twitter, increases in debt servicing costs are small compared to rises of other production costs (e.g. labor). So if the economy does crash after rate hikes, it must be because of some other/indirect cause.
As always, I start the first Finrestra podcast episode of a month with a selection of the financial news of the previous month. Listen to the episode of 7 February 2022 on Spotify, Apple Podcasts or YouTube.
I also covered the news in the first Finrestra episode of December:
The German Federal Constitutional Court (Bundesverfassungsgericht) made a decision concerning the ECB’s QE program1.
This article explains how the ECB can defend itself.
But I want to play devil’s advocate, and defend the German judges.
Despite buying thousands of billions of euros worth of bonds, the ECB has undershot its inflation target for years. The Court has a point that buying vast amounts of sovereign debt doesn’t seem proportional to this disappointing outcome.
In fact, the ECB could achieve its primary objective of price stability with a much smaller balance sheet. For example by dual interest rates. Or by helicopter money.
Second, the Court could prohibit the Bundesbank from participating in QE. But buying German bonds was not needed for monetary policy anyway! It was a political decision to buy bonds proportional to the national capital key in the ECB.
Finally, the decision of the Court should force European politicians to fix this mess. Maybe the ECB should have a dual mandate like the Fed has, so inflation and employment carry the same weight in monetary policy decisions. Or they could change the structure of the Eurosystem. Do we still need 19 national central banks when we have the ECB? Sounds like a make-work scheme to me…
This post highlights the financial problems caused by (the reaction to) the coronavirus. I look at the balance sheets and cash flows of five sectors. The five sectors are (1) businesses that continue operations, (2) businesses that are closed due to the coronavirus, (3) households, (4) the government and (5) banks.
I haven’t posted on the blog in a while, but I’m very active on Twitter.
Here’s my 3 point plan for the ECB:
(1) The ECB should issue bonds, which are risk free (the ECB cannot default on euro liabilities). It should buy every sovereign bond trading at a yield of 40 basis points or more above the yield on the ECB bonds.
(2) The ECB should set the interest rate on TLTROs at -5% until six months after the coronavirus public health crisis is over.
(3) The ECB should do helicopter money as soon as businesses are operational again, because the outlook for price stability is bleak.
Total radio silence while markets are imploding. This is Trichet level incompetence. Criminal!!!
The ECB, government leaders and the banking sector must act immediately to stop the financial panic caused by the coronavirus.
A recession can still be avoided.
Banks should provide bridge loans to businesses suffering from the corona shock.
The ECB should do a TLTRO-like operation, providing cheap funding proportional to banks’ SME/corporate credit portfolios. Make the terms of the ECB loans conditional on coronavirus metrics. For example: banks should repay 4 months after the last new COVID-19 case is detected in the EU.
If Europe’s leaders fail to act decisively, the financial costs will snowball.
But the reaction of policymakers might.
The direct impact of the coronavirus on the economy is limited. Unlike disasters such as hurricanes or earthquakes, there is no material damage. Few workers have been incapacitated by the virus.
Once the spread of the virus is under control, the economy can recover quickly.
The greatest risk is that politicians and central bankers will let financial uncertainty get out of hand. The stock market has taken a hit. Some companies will need to defer payments.
Continue reading “The coronavirus won’t cause a recession”