Central banks have probably realised by now that an interest-rate turnaround truly worthy of the name is scarcely likely any more. The collateral damage would simply be too great. A significant increase in interest rates would cause real-estate, bond and equity prices to collapse, put corporate and government solvency at risk and ultimately shake the entire banking system to its foundations. No central banker wants to risk that. Since there are no historical examples of such low interest rates, to say nothing of negative rates, central banks are walking a fine line in unknown territory. They want to avoid a financial market crash without risking a loss of confidence in the value of money.
This fine line is also reflected in the extremely cautious statements made by Fed Chair Jerome Powell during the last press conference. They ranged from reassurances that the expectations of some governors, as expressed in the so-called “dot plots”, that interest-rate increases could already be expected in 2022 should not be misunderstood as a forecast, to a declaration that the Fed would monitor inflation risks closely and only react if there were persistent changes. Repeated remarks that forecasts are ultimately highly uncertain were used to justify the use of “outcome”-oriented policies, which consist of first waiting and calmly watching developments unfold before taking action.
An evasive answer was given to the most interesting question, namely how long a period of inflation below the two per cent mark the Fed would consider relevant, as it would have allowed the “inflation credit”, or inflation tolerance for coming years, to be determined. Powell, however, does not want to reveal his cards to such an extent, so he simply referred to the Fed’s discretion ary leeway and stressed that the market should cautiously prepare for an end to bond purchases and possible key interest-rate increases later in the future.
Further recovery of the US labour market is required before it would even consider departing from its ultra-loose monetary policy. In spite of a record 9.2 million job openings, the number of people employed is still around 6.8 million lower than before the pandemic. One reason is that the US government’s generous support programmes are still discouraging many people from looking for work, which could change when they expire in the autumn. In addition, the use of expansive fiscal policy, with an expected record level of new debt of around 15 per cent of gross domestic product (GDP), is creating an economic boom (see Figure 1) that is aimed at increasing employment and wages. A turnaround in spending should not be expected. Based on the Biden administration plans, the budget deficit will not fall below five per cent of the GDP again until fiscal year 2027.
Without government aid and cheap money, we clearly would not have seen the economy back on track and picking up speed again so quickly. Once the economy is back on track, however, it should be able to continue on its own without fiscal stimulus. But this kind of “prophylactic” deficit spending appears to be politically opportunistic as long as even the slightest doubt remains. This also applies to European countries, where it is very unlikely that deficits will once again fall below the three per cent maximum required under the Maastricht Treaty in coming years.
To prevent these large deficits from becoming too much of a burden on the public treasury, central banks have to help governments by pro viding cheap money. Fiscal policy provides the wood to keep the economic fire blazing, while central banks supply the oxygen. The amount supplied in the eurozone was actually limited. The ECB’s original purchase programme, the Public Sector Purchase Programme (PSPP), for example, was limited to 33 per cent of a eurozone country’s eligible government bonds. This upper limit was, however, effectively removed when the ECB implemented its Pandemic Emergency Purchase Programme (PEPP) and, according to our estimates, has already been exceeded for some countries.
Based on the total national debt in the eurozone, i.e. including debt owed by federal states and municipalities, the ECB (or central banks in the eurosystem) hold close to 21 per cent of the national debt outstanding. This percentage will continue to increase if bond purchases continue as planned. We are, as a result, slowly approaching the situation in Japan, where 39 per cent of the total national debt is already held by the central bank and, therefore, ultimately owned by the state (see Figure 2).
This funding method, which makes one think of a Ponzi scheme, where the winnings received by earlier participants in the game are paid by the newcomers, is cleverly concealed by using central banks as a middleman. A perpetual motion machine like this can only work as long as people fail to question the future value of money. After decades of central bank support, Japan can now finance a national debt of around 260 per cent of GDP at practically no cost, and has so far not suffered any serious loss of confidence in the value of money. It is remarkable how this form of indirect government funding, which is ultimately just a bill that future generations will have to pay, seems so natural and harmless to us today.
Current discussions about intergenerational equity and sustainability should therefore not be limited to the climate debate and the environ mental prospects of younger generations, but should also address the economic prospects of those generations. People under the age of 45 today have to continue paying into an inter generational contract for more than 20 years before being eligible to receive less than their parents and grandparents received.