Economic Stimulus Alive and Kicking in EU

Janet Yellen and company pretty much followed the script during last week’s Federal Open Market Committee meeting, raising interest rates another .25 percent and signaling three rate hikes in 2018.

We tend to focus primarily on Federal Reserve actions, but it’s important to remember the Fed isn’t the only central bank game in town. While it nudges interest rates slowly upward, the European Central Bank is standing pat on economic stimulus. And there’s no indication that is going to change in the near future.

With its latest rate hike, the Federal Reserve has pushed the Federal Fund Rate to 1.5%. That’s the highest we’ve seen since 2008. Even at that, we’re still well below the 5.25% peak hit during the last expansion.

Meanwhile, ECB chair Mario Draghi announced back in October that quantitative easing would live on in the EU.  The European Central Bank plans to extend its bond-buying program deep into 2018, continuing the flow of easy money into the European Union. Last week, Draghi stuck to that course, saying the inflation outlook remains “muted.” The ECB plans to hold interest rates down for “an extended period.”

The Bank of England raised its key interest rate last month, but officials say they have no plans to follow up in the near future.

So, why the reluctance to move away from stimulus if the economy has recovered? Ryan McMaken at the Mises Institute provides some analysis.

Draghi “repeatedly stressed that what the eurozone is experiencing is no longer a mere ‘recovery’ but instead an ‘expansion…'” One is left wondering, however, why the ECB refuses to let up on the stimulus if the economy is doing so well.

Over the past decade, central bankers have gotten into a fairly predictable habit of declaring the economy to be “strong” or “robust” while simultaneously refusing to scale back the central bank’s stimulus. As numerous commentators have pointed of, though, Europe’s monetary policy remains in the service of debt-laden governments which rely on rock-bottom rates to keep debt payments low. Moreover, the threat of a banking crisis in Italy isn’t exactly exactly motivating central bankers to raise rates.

From their perspective, it’s better to just keep rates low indefinitely, and hope for the best.

This makes one wonder how the Fed can continue to push rates higher. The US government continues to spend money like a drunken sailor and if the GOP manages to push its tax reform plan through, we can expect even more debt over the next decade. The government is going to need to keep interest rates low in order to manage its debt service.

It won’t take much to convince the Fed to reverse course. We’d expect normalizing to stall the minute there is the slightest economic wobble.

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