Headlines will no doubt trumpet the 0.25 per cent reduction in the main interest rate to 0.5 per cent. But those who look deeper will note that the ECB did not reduce its deposit rate (currently at 0 per cent), probably because it did not want to be the first main central bank to move into the zone of negative official interest rates. And anyone who feels that the financial sector is treated more favourably than the real economy may have spotted that an interest rate which applies to that sector alone – the Marginal Lending Rate – was cut by a larger 0.5 per cent to 1 per cent. This rate also usually applies to one of the ECB’s bailout mechanisms – Emergency Liquidity Assistance.
But why have interest rate cuts not worked so far? It’s a problem for their advocates because we’ve seen plenty of cuts already, and yet the Eurozone economy is shrinking rather than improving. The series of rate cuts began in the autumn of 2008, when the main official rate was 4.25 per cent. With two false starts, we have seen rate cuts totalling 3.5 per cent until yesterday. If cuts of 3.5 per cent have not worked, why will a further 0.25 per cent do the job? It will not.
If we look at why the interest rate weapon has disappointed, we can find a possible answer on the other side of the balance sheet – from borrowers. In my view, the impact of falling interest rates on savers and the overall economy has been underestimated in conventional theory.
In fact, the credit crunch has had a profound impact on human psychology. We now exhibit different behavioural patterns to before the crisis, meaning that stimulative monetary measures have lost much of their power. And this situation gets worse as we approach zero interest rates. It also means that economic models that do not allow for this change will continue to make forecasts which are different to what actually happens – hence the frequent use of the words “surprise” and “unexpected” in relation to economics and finance.
Or let me use the statement of the president of the ECB Mario Draghi at his press conference yesterday. Policy has been “extraordinarily accommodative throughout,” he said. But if we take him at his word, then why aren’t things getting better?
Those who watched Draghi speak should also have noted that he mentioned rising Eurozone stock markets first when he listed the effects of easing monetary policy. This subliminal gesture means that nearly all the world’s main central banks are using stock market values as a benchmark, and indeed as a policy measure. So your investments still seem to be protected by what was originally called the “Greenspan put”.
But a cautionary note. Central bankers, like all of us, should remember a Rolling Stones lyric: “You can’t always get what you want”.
Shaun Richards is an economist, and writes for Mindful Money. www.mindfulmoney.co.uk