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Monetary policy is reaching its limits

D.he prospect of a vaccine against the corona virus does not currently change the economic outlook in the major central banks. In the medium term, the vaccine is good news, US Federal Reserve Chairman Jerome Powell said at the ECB’s monetary policy forum. The US economy is currently on a solid recovery, but that recovery has not spread to all sectors of the economy and he prefers the rich rather than the poor. The greatest threat to the upturn at the moment is the spread of the virus.

ECB President Christine Lagarde said that the prospect of a vaccine, which of course gives cause for hope, is still associated with great uncertainty about when it will be spread. But even if the vaccine is there and the current pandemic is over, it cannot be ruled out that companies and private households will behave very cautiously with a view to the future risks of pandemics or other major risks.

The ECB forum, which this year did not take place in Sintra, Portugal, but digitally, had previously dealt with the possibilities of monetary policy in the current situation. The Mannheim economist Klaus Adam sees monetary policy in a dilemma. On the one hand, the decline in interest rates for safe capital investments that has been observed in numerous countries for many years has mostly structural causes: The usual suspects in the work of economists are the decline in economic growth, the aging of societies, the transformation of capital-intensive industrial societies into knowledge-based service societies and one sustained demand from many investors for safe investments.

In Adam’s analysis, the decline in interest rates is combined with a worrying increase in price spikes in asset markets, especially real estate and stock markets. According to a widespread, not uncontroversial interpretation, the sharp price changes also express irrational behavior on the part of investors – for example in the form of exaggerated optimism. Adam advocates the thesis that these high fluctuations in asset markets have a negative effect on the economy and thus on the already very low interest rate through an inefficient allocation of capital. This is a very uncomfortable situation for monetary policy because it has little room for maneuver for any further interest rate cuts that may be necessary.

Many economists and central banks are considering higher inflation targets in this situation. The idea is to encourage businesses and households to invest and spend more in the face of the prospect of higher inflation rates, which will lead to higher economic growth and higher inflation. Adam mentioned one problem, however: if central banks fail to try to meet their inflation targets in this way, their credibility will suffer even more. The American procedure would offer an alternative: There the Federal Reserve has announced that it will stick to its inflation target of 2 percent, but accept a slightly higher inflation rate if the increase in the price level had previously remained below the 2 percent mark for some time.

The recognition of a limited role for monetary policy arouses interest in an expansionary financial policy. Central banks are also in favor of this. At the ECB forum, economist Evi Pappa, who teaches in Madrid, pleaded for a “generous financial policy in the interests of young people”. Pappa hopes that an increase in public investment will generate significant impetus for economic growth.

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