The European Central Bank is signaling the end of its grand experiment in negative interest rates, which it began in 2014.
Some critics say policymakers there have kept interest rates too low for too long. That makes it harder to fight inflation, which is hitting Europe as well as the United States. But the politics had their reasons.
Most of us grew up in a world where if you put money in the bank, you get interest—maybe not much, but something. Think of negative interest as the opposite: you pay the bank to keep your money.
“The idea behind it is to make saving so unattractive that banks grant more loans and households no longer save, but instead invest or simply consume,” says Carsten Brzeski from ING Research.
Until 2014, when the European Central Bank was the first major central bank to try, making interest rates negative seemed like defying economic gravity.
“I think most of us thought, ‘You know, that’s a nice idea, but it could never really happen,'” said David Wessel, a senior fellow at the Brookings Institution.
But it happened and it helped depress the value of the euro. This in turn boosted the European economy by making its goods more attractive to foreign buyers. Just like the Federal Reserve, the European Central Bank is now trying to phase out access to easy money.
“The ECB has a pretty tricky job here, much tougher than the Federal Reserve,” Wessel said. “The Fed has a strong economy and too much inflation. Europe, partly because of what is happening in Ukraine, has a weak economy and too much inflation.”
That means Europe’s central bank is likely to be much more cautious than policymakers here in the US, Wessel said.
And according to Claus Vistesen of Pantheon Macroeconomics, economists will be watching to see if a slow and steady approach can be maintained.
“If the ECB hikes interest rates now, and then, when you talk in six, nine months, they might lower interest rates again, that would be catastrophic for the ECB,” Vistesen said.
It’s a real risk for the economy of the European Union, which is still grappling with the pandemic and a war right over its borders.
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