Bells of change are ringing in the monetary policy of the European Central Bank. The governor of the Bank of Spain, Pablo Hernández de Cos, proposed this Wednesday to modify the inflation target set at 2% to achieve more scope for monetary policy in the face of the challenges posed by the coronavirus crisis. It is not a new idea. The Eurobanco has already launched this idea as a legacy of the Draghi era, the president of the ECB who promised to do whatever it takes to save the euro in the previous financial crisis, but his successor Christine Lagarde has not caught the bull by the horns. Price stability is one of the axioms of neoliberalism that the Frankfurt hawks defend most strongly, despite the fact that several consecutive quarters of negative interest rates have shown the low impact on prices.
Nadia Calviño points out to the banks as “essential in the solution” to get out of the economic crisis
Herández de Cos has pointed out that “it would be desirable to establish an inflation target of 2%, interpreted symmetrically, in the sense that I have just indicated. This would have the triple advantage of clarifying the numerical target, raising it with respect to the current one (which in in any case it is less than 2%), thus giving more space to our interest rate policy, and completely eliminating the possible perception of asymmetry in the current formulation “.
The reality is that the Treaty on the Functioning of the EU does not mark a specific figure and only establishes as a “main objective” of the monetary authority “to maintain price stability”, which was established in 1989 “below 2%” and it tried to ‘make it more flexible’ in 2003 due to the dot-com crisis to “below, but close to 2% in the medium term”.
Faced with the deflationary threats that the coronavirus crisis has caused, the governor of the Bank of Spain proposes a new vision so that the “response to deviations in inflation below its target will be as strong as to deviations above it, as well as our determination to achieve symmetrical results in the evolution of inflation around its objective “.
Hernández de Cos recalls that the Federal Reserve, the United States central bank, at the end of August 2020 already carried out a strategic review that has led it to adopt a policy of “asymmetric average inflation targeting” whereby in “periods with a inflation persistently below 2%, it will try to keep inflation moderately above 2% for a certain time. ”
As lower interest rates are needed to stabilize inflation, Hernández de Cos gives as an example that “with an expected inflation of 1%, to set the real interest rate at, say, −2%, it would be necessary to reduce the rate nominal to −1%, the governor of the Bank of Spain rejects that rates can be lowered even further (they are currently at -0.5%) because “commercial banks would suffer negative returns on a large part of their assets, which would adversely affect its profitability and, ultimately, its financial intermediation capacity, with the consequent negative impact on the supply of credit, economic activity and inflation.
According to the governor of the Bank of Spain “there is a lower bound than nominal interest rates, so that, if the central bank reduces interest rates below that level, the effect on the economy may be contractionary, rather than expansive, due to the negative effects on the financial system as a whole “.
Public aid to companies to avoid the deterioration of banks
The governor of the Bank of Spain also asks the Government for “support to non-financial companies” that would alleviate “over-indebtedness problems” of companies that are considered viable, “which would facilitate their survival and a more expansive behavior of investment and employment in recovery. ”
For Hernández de Cos, one of the most worrying aspects of this crisis is the risk that the companies’ initial liquidity problems “turn into solvency problems”, which would not only cause a destruction of the productive fabric and employment, “but that would also end up affecting the resilience of the banking sector. ”
With public aid to companies, “this support would prevent a potentially significant deterioration in the financial position of the banking sector, which is crucial to prevent this crisis from incorporating an additional financial element that could make it much more persistent, as the previous one demonstrated international financial crisis “.
Hernández de Cos does not specify whether this aid should be direct or with other formulas, but he does emphasize that “the banking sector could, through the granting of credit to families and companies, contribute to the reactivation of the economy once the pandemic, which, surely, will require the proper functioning of the credit channel, so relevant in European economies. ”
In this sense, the governor of the Bank of Spain is aligned with the Vice President of Economic Affairs, Nadia Calviño, who understands that the financial sector is key to saving “over-indebted” companies when it announced a new direct aid framework for all of 2021.