Has the European Central Bank (ECB) reached its limit? It seems like the Frankfurt-based institution has fired every bullet in the chamber and nothing has hit the intended targets. Instead, economic growth has been anemic, sovereign debt levels are increasing, banks are highly leveraged, and consumers are stuck with their deposits returning pittance. With a new face but the same Keynesian thinking at the helm of the ECB, the consensus is that the organization will deepen negative interest rates while trying to incorporate woke measures into monetary policy. However, another unconventional tool has resurfaced, and it might allow it to introduce the eurozone version of the Green New Deal.
What is this policy proposal? Dual interest rates.
Dual at Dawn
This month, ECB chief Christine Lagarde will undergo a strategic review of the entity’s policies and objectives. Reportedly, the ECB is set to examine dual rates, a mechanism that allows the central bank to target different rates for deposits and loans. Experts say this would be more effective than quantitative easing, subzero interest rates, and forward guidance.
Here is generally how it would work: The central bank would pay positive rates when receiving deposits from commercial banks and then lend to those banks at deepening negative rates. In the ECB’s case, it would raise the interest rate on deposits and slash the rate on loans. Inevitably, the ECB would gradually eliminate its capital and suffer losses, though former ECB head Mario Draghi was unconcerned by this when he discussed the maneuver in September. This was likely part of his mantra, “growth at any cost.”
Late last year, the ECB cut the rate banks fund lending to the economy and increased the average rate that banks receive on their deposit. Prior to his exit, Draghi introduced the concept of “tiered reserves.” This would give the central bank the opportunity to set the rate on deposits that banks hold with the central bank independently of the policy rate which affects money markets.
Over the next year, a potential scenario could involve the ECB extending targeted longer-term refinancing operations (TLTROs) – financing to credit institutions with favorable borrowing conditions so they can lend to Main Street – by five to ten years at a negative rate of 1%. Simultaneously, banks could raise rates at different levels.
For example, according to the Financial Times, a ten-year TLTRO at –1% “would be game-changing” over the present three-year TLTRO at –0.5%.
Some economists have been recommending dual rates since last summer, positing that it would reverse the weakening that has been prevalent throughout Europe. Critics warn, however, that dual rates would affect the central bank’s balance sheet because if these targeted loans fall below the interest rate the ECB earns on reserves then its net interest income would decline. Moreover, these detractors have also cited the likelihood of banks gaming the dual-rate system.
A handful of other experts propose dual currency, separating the monetary system into cash and digital. They contend a dual money infrastructure that would facilitate the deepening of negative rates even more because cash would lose its value – in both goods and virtual currency. Because of this, there is zero benefit to holding cash relative to bank deposits, allowing central banks to either implement NIRP or lower negative rates without causing bank runs during a recession. Considering that more central banks are thinking about creating their own e-currency, this is a frightening proposal.
Global financial markets might get a better idea of policy in 2020 and beyond when the ECB convenes in Frankfurt at the end of January.
A dual-rate policy is yet another central planning technique aimed at manipulating the economy. It has only been tried a handful of times, most famously in China during the 1980s and 1990s. It is one of those measures that emanate from the mind of Dr. Frankenstein – and we all know the ending of that tale.
To think this is what has been missing all along to stimulate the European economy is laughable. The ECB has thrown everything at the economy: bond-buying, historically low rates, bailouts, and liquidity injections. To date, nothing has worked out for Europe. Now that there is an eco-zealot and social justice paragon leading the central bank, someone who wishes to coalesce monetary policy with climate change, you can anticipate more of the same or worse.
The eurozone is a sinking ship, and Great Britain saw the gaping holes causing the ship’s collapse. The ECB would be better off not doing anything.
Read more from Andrew Moran.