On Thursday the European Central Bank announced a highly anticipated plan to step up the level of economic stimulus provided through the banking system to European Union countries.
The package is complicated, but we can all appreciate one part of the plan. The ECB is now going to be charging European banks to store their money. Typically a Central Bank like the Federal Reserve will pay a small interest rate to banks on their cash reserves, but in Europe this interest rate has now been set at -0.1 percent. The message to European banks is clear: Don’t hoard money; get out and lend to consumers and business, and do it now.
It’s interesting to note while the U.S. Federal Reserve moved more quickly to stimulate our economy and has continued to stimulate more aggressively since the 2008 crisis, the Fed is now scaling back the level of stimulus as it reduces its bond buying quantitative easing program.
The Europeans on the other hand were focused on the threat of inflation (rising prices over time) recognized to result from aggressive monetary stimulus. I guess the memories of the Weimar republic early in the 20th century, in which stories of prices rising so quickly it took a wheelbarrow of paper money to buy a loaf of bread were still too fresh.
So what changed the minds of the Europeans, especially at this point which seems late in the post 2008 financial crisis game? Well once again, the motivator is inflation, but this time it’s the lack there of.
Economists welcome a small amount of inflation. Low and controlled inflation provides a subtle tail wind for an economy, and tends to lead to employee raises and new jobs as business revenues rise due to higher prices. Inflation which is to low is a sign of a weak economy, but the real risk occurs when inflation falls to super low level and the trend actually reverses and turns into deflation (prices generally falling over time).
While things getting cheaper may sound like a good thing, central banks are terrified of deflation. Deflation in their eyes saps economic activity and severely hurt lenders (banks).
The real rub may be despite all this monetary tinkering, the Europeans may need to change more than interest rates to avoid a deflationary future.
In its base form, economics is the study of human behavior. The key part of this sentence is the word “human." Europe is an aging continent, and more importantly the population is not embracing the fundamental economic growth plan called parenthood.
You want to get your population spending and working hard? Give em all some kids. Birth rates in Europe are very low and falling, and it’s kind of difficult to grow an economy over time with less people, especially young people.
Unless Europeans embrace parenthood and all the societal economic benefits coming with it, we may see the continent mired in a permanent malaise. Tinkering with interest rates may be easier, but over the long term every society needs kids. The Europeans outta get busy (pun intended).