A significant interest rate hike in the Eurozone is dangerous

In the United States, a sharp rate hike seems like a good option, but it is risky for the eurozone.

André Kolodziejak, economist at the European Commission, writes: In Economists Journal ESB. A sharp rate hike would further lower already low growth expectations for the eurozone and exacerbate debt problems. This move will not have a high inflationary effect.

Negative demand shock in the Eurozone

In its World Economic Outlook for April 2022, the International Monetary Fund has called for raising interest rates in the US and the eurozone in some significant steps to curb rising inflation. According to Kolodziejak, that advice fits the US better than the eurozone. “Unlike US inflation, current European inflation is largely supply-driven rather than demand-driven. Both economies are dealing with sharp rises in commodity prices, but the European economy is facing significant negative demand shocks.

Kolodziejak leaves no room for interest rate hikes in the eurozone. European unemployment is high and economists expect a recession. The EU consumer confidence indicator has slipped below the lows of the coronavirus crisis, with consumer inflation expectations falling and investment slowing.

Low interest rates are logical due to the aging population

The ECB’s loose monetary policy sees current inflation as a misnomer. Money has moved less and less rapidly in the economy in recent years, so prices tend to rise less than the money supply.

The author believes that the current low interest rates are related to low fertility rates and an aging population. This population growth causes a structural shift towards labor-intensive services, associated labor shortages, savings surpluses, an increase in the amount of capital relative to GDP, and a decrease in the marginal productivity of capital. Capital yields are too low, according to Kolodzijak, and the ECB needs to reduce its spending through a lower policy rate and unconventional policy.

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