Home > Uncategorized > Europe has not yet hit the zero lower bound and interest rates are not yet extremely low

Europe has not yet hit the zero lower bound and interest rates are not yet extremely low

At this moment, the ECB is increasingly chided for keeping interest rates low. Hmmm… ECB interest rates are indeed at a historical low. And so are interest rates paid by most Euro Area states. But it is only since 2012 (four years after the crisis!) that average Euro Area interest rates for non financial companies and households (new loans) are cheaper than before the financial bubble. But even then, the present average 3% on outstanding loans is, when we take the decline of core inflation of around 1 to 1,5% into account, not extremely low. Considering higher interest rates and a larger decline of inflation and, at present, even deflation in Spain and Portugal this holds of course a forteriori for these countries.

Outstanding amountWhich is one reason for the devastating level of non performing loans in Europe. According to J. Mason, short termism (companies prefer share buybacks over productive investments) has led to a situation where low interest rates do not or hardly boost investments. But low rates can alleviate the burden of households with high (mortgage) loans, as they can refinance these loans at a lower rate, therewith as well solving part of the plight of families as solving part of the non performing loans problems (massive evictions of house owners, which is the Troika’s prefered non-performing loans policy in countries like Cyprus, Spain and Greece, only lead to additional suffering, empty houses and lower house prices). Refinancing will, as many mortgages have long initial maturities, take quite some time – maybe even up to a decade. Interest rates my have to stay low for that long. And they will probably stay low for that long, as increasing uncertainty about pensions add to the deflationary environment because people start to save more – therewith not just depressing demand but also lowering interest rates. It’s surely not a good time to be a banker…

  1. Fokke Oeseburg
    November 10, 2015 at 10:43 am

    Dear Mr. Knibbe,

    I am intended to think that your heading is not correct. The Zero Lower Boundary refers to the short-term nominal interest and the short-term interest set by the ECB is nearly Zero! (see definitions of ZLB below).

    I am intended to agree with the meaning of your comment; real interest rates are not very low, especially in Spain, Portugal and Greece.

    Definitions of ZLB

    1) A situation that occurs when the Federal Reserve has lowered short-term interest rates to zero or nearly zero. When interest rates are this low, new methods of economic stimulus must be examined and implemented (Reference Investopia).

    2)The Zero Lower Bound (ZLB) or Zero Nominal Lower Bound (ZNLB) is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the capacity that the central bank has to stimulate economic growth (Reference Wikipedia).

    • merijnknibbe
      November 10, 2015 at 9:08 pm

      Dear mr. Oeseburg,

      thank you for your comment. In a technical sense you are totally right: the title in fact compares apples with pears.

      However, I do think that too much attention is given to the policy rates of the central banks which (though indeed very important) are not as important as sometimes indicated in economic models. For one thing because at least some models do not pay attention to ‘legacy’ debts and assume that every period all debts are refinanced. About this, look here (second paragraph) http://jwmason.org/slackwire/on-other-blogs-other-wonders-4/

      I’m also working on historical interest rates and at this moment I’ve tinkered what’s possibly the best long term series on rural medium term interest rates (1537-1830). This series (which of course consists of a number of sub series, most of which have been published by other researchers) is about new loans, not about average mortgage rates on existing debts. When we compare the ECB new loans series with this historical information they are indeed very low. But not totally extreme. Unlike the policy rates of the ECB and rates payed by, governmentswhich, compared with the historical data, which are for many countries indeed extremely low.

  2. guest
    November 10, 2015 at 5:02 pm

    Are you basically saying that we should look at the real interest rate? How did it evolve in a medium-term perspective (say 2000-2015)?

    • merijnknibbe
      November 10, 2015 at 9:14 pm

      We should indeed also look at real rates, not to predict investment behaviour of firms but to look at the ability of households and companies to service their debts, However – it is a bit of a problem how we have to calculate the real rate. An argument can be made that for households the development of disposable income per is a better deflator than the price level, while at the same time for many countries a difference has to be made between ouseholds mainly receiving some kind of welfare, households with a wage income and households without an income (many (90% or so) unemployed in Greece do not receive any kind of welfare at all, I’m told). It’s in fact complicated. But it is interesting to look at real rates in different countries, calculated using the CPI index as well as using hourly wages

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