Commerzbank Expert Cheap Money Weakens the Euro Zone

Companies are increasingly losing trust in the European Central Bank. It may explain why the euro zone's economy is still struggling to get up and running, argues the chief economist of Germany’s second-largest bank.
Graffiti near the headquarters of the European Central Bank in Frankfurt.

The dilemma is obvious: The European Central Bank has been pumping hundreds of billions of euros into the market for a year but has failed to stimulate either growth or inflation. What's going wrong?

The ECB points to the private banks which, especially in the southern reaches of the monetary union, continue to carry bad debt and aren't issuing any new loans to companies and private individuals who are often highly in debt.

The ECB hopes that, with time, banks and their customers will bring their books into order so that the knot is untied and the low interest rates can kickstart the economy.

But ECB President Mario Draghi's hopes are fated not to be fulfilled – even if he decides to print money even faster this week.

The basic trust of many entrepreneurs has been undermined – and not only in Germany.

Instead, it is time to acknowledge the mistakes and do some listening in the economy. If you speak with entrepreneurs who subscribe to the outlook of 20th-century economist Joseph Schumpeter, you’ll hear: “This is bound to go badly in the long run.”

The entrepreneurs believe politicians have central bankers under their thumbs, and they fear the ECB is not solving but simply whitewashing the problems of the monetary union. Some even consider the very existence of the monetary union to be endangered.

The basic trust of many entrepreneurs has been undermined – and not only in Germany. Their intuitive skepticism is justified. Entrepreneurial energies, instead of being released, are being weakened over the long term by loose monetary policy.

First, negative interest rates lead to a misdirection of capital. When near zero, interest rates are essentially abolished and lose their guiding function. Low-return investments seem to become justified; companies can invest in anything that doesn't bring them a loss. Ultimately, however, this lowers the profitability of companies.

Moreover, there is a danger that, in searching for returns on their money, investors will push real estate prices up even further. The German real estate market has entered a phase of exaggeration. This could end in a few years with a price bubble that will severely damage the economy when it bursts.



Second, the loose monetary policy of the ECB has led to a slowing down of reform efforts by governments. Because of the ECB’s negative interest rates, Italy’s prime minister is saving lots of money on his sovereign debt. He feels little pressure to improve the miserable framework conditions for companies in order to boost economic growth and tax revenues.

Portugal's new government would scarcely have canceled the successful reforms of its labor market at the expense of companies if the ECB were not for the most part protecting Lisbon from the negative consequences of this change of policy.

Third, many politicians are blaming the negative consequences of cheap money on the market economy. For example, the German government is seeking, through state rent controls, to stop the rise of real-estate prices and rents that has been fueled by low interest rates, even though this will make apartment construction unprofitable and thus exacerbate a shortage of housing across the country.

Loose monetary policy therefore threatens to set in motion a spiral of intervention that limits freedom of contracts and impedes entrepreneurial energies.

The lack of the constructive impact of interest rates, the risk of bubbles, the slowing down of reform, a spiral of governmental interventions – negative interest rates are weakening both the framework conditions for doing business and companies themselves. Firms are slowing down, also with regard to profit growth. If financial investors come to factor that in completely, then the ECB will no longer even be able to push up share prices with its policies.

Today, companies with an eye to the future are reacting with restraint to the foreseeable worsening of the surrounding economic environment. For this reason as well, companies in the euro zone have increased their investments only slightly since the subsiding of the financial crisis in 2009; investments are still 13 percent lower than before the outbreak of the crisis.

How can the ECB overcome this dilemma and regain the violated trust of entrepreneurs? The ECB should put its faith not only in itself, finance ministers and markets, but also speak with industry representatives. Then the ECB would realize it needs to end the crisis mode and send out a signal of renewal – with a concrete plan for how it intends to return step-by-step to appropriate rates of interest.


To contact the author: [email protected]