The ECB sees the neutral interest rate at one and a half to two percent.
(Photo: dpa)
The European Central Bank (ECB) has already raised its key interest rate from zero percent to two percent since July. With a view to the next meeting of the Governing Council of the ECB in two weeks, the question arises as to how far up it should go. The so-called neutral or balanced interest rate plays an important role here. This is the interest rate that brings an economy into balance and ensures the targeted inflation rate of two percent in the long term.
If the central bank wants to accelerate the return to the inflation target, it has to set its key interest rate above the neutral interest rate for a while. This is the center of gravity of monetary policy. But the ECB only sees this neutral interest rate in a range between one and a half and two percent and is therefore aiming for a key interest rate that is too low, with which it cannot achieve equilibrium with low inflation.
The fact that the central bankers underestimate the neutral interest rate is mainly due to the fact that the current calculation models for determining it are shaped by the long phase of low inflation rates before the outbreak of the corona pandemic. During this period, inflation rates were pushed down by globalization, particularly by China’s integration into the world economy.
As a result, inflation in the euro area has been surprisingly low for years, even though the ECB’s monetary policy was loose. Apparently, the euro area tolerated ever lower key interest rates, which the current estimation models incorrectly interpret as a decline in the neutral interest rate.
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But because of rising political tensions between the US and China, globalization is now on the wane. Therefore, estimates of the neutral rate are likely to go higher going forward. But because this is happening slowly, they will still be too low for a long time.
Jörg Krämer is chief economist at Commerzbank.
(Photo: Commerzbank)
Against the low estimation results used by the ECB, it can also be objected that a neutral interest rate of just under two percent after deducting the ECB inflation target of two percent would mean that the neutral real interest rate, i.e. the neutral interest rate minus the rate of inflation, would be negative .
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This contradicts the idea that a balanced interest rate should reward and not punish saving, i.e. not consuming. Anyone who saves should later be able to use their savings to buy more goods, not fewer, despite inflation. The neutral interest rate should therefore be well above the ECB’s two percent target.
Estimates of the neutral interest rate below 2% are like a bent compass needle. If the ECB relies on them, they will not raise their interest rates far enough and end the rate hike process too early. This is exactly what it looks like at the moment with a view to spring next year. Inflation is therefore likely to be well above the promised two percent for years to come.
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