On March 7th, the European Central Bank’s Governing Council decided to keep its three policy-setting interest rates unchanged. The so-called deposit facility, the refinancing rate, and the marginal lending facility remain unchanged at, respectively, 4.00%, 4.50%, and 4.75%.
The decision on the interest rates was unsurprising; any adjustment in either way at this point would have been sensational. But there were two pieces of information in their announcement that should attract more attention than they have gotten—especially since, in both cases, they convey a grim outlook on the euro zone’s economy.
The first piece is a statement on the economic growth in the euro zone:
Staff have revised down their growth projection for 2024 to 0.6%, with economic activity expected to remain subdued in the near term. Thereafter, staff expect the economy to pick up and to grow at 1.5% in 2025 and 1.6% in 2026
These are intolerably low growth rates. They are the rates at which a well-functioning economy grows when it is in a mild recession; the best one can say about the ECB’s growth outlook is that they predict that the euro zone is going to remain in a more or less perennial state of economic stagnation.
Not only do these growth rates spell trouble for the labor markets around Europe—it will be exceptionally hard to keep unemployment down—but they also suggest significant, and lasting budget problems for Europe’s large welfare states. Please pay special attention to the last sentence in this paragraph (emphasis added):
The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that policy rates will be set at sufficiently restrictive levels for as long as necessary.
This is a declaration that the ECB has once again made the fight against inflation its primary policy goal. In doing so, the central bank is going to pay at best marginal attention to any governments that are having problems financing their deficits.
As such, this message could not have come at a more noteworthy point in time. The euro zone and the EU as a whole are in the preamble of what is likely going to be a long, agonizing recession—especially if the ECB’s GDP growth forecast turns out to be correct—during which governments all over Europe will have mounting problems with budget deficits.
If we disregard the artificial economic shutdown related to the 2020 pandemic and the fiscal problems it caused, the last time Europe was hit by a widespread, serious recession was in 2008-2011. Often referred to as the Great Recession, this was the first adverse economic event to test the resolve of the ECB:
- Would they stick to their goal of low inflation with unwavering commitment, or
- Would they cave in, break their own charter, and start printing money to support the debt-burdened welfare states of the euro zone?
The ECB did the latter. When the Great Recession broke out, it started buying massive amounts of debt from credit-troubled governments in the euro zone. As I explained in The Rise of Big Government (pp. 106-113), when that recession began and country after country in the euro zone was hit by crippling credit downgrades (p. 113),
the ECB expanded lending to governments by 8-15 percent per year almost every year during the Great Recession (and continued to do so again after a brief pause in 2014).
Furthermore, I noted,
Even more conspicuous is the ECB’s use of its program to rescue troubled banks as a tool for funding welfare states with major credit problems.
In other words, not only did the ECB directly buy treasury securities from countries with deteriorating credit ratings, but it also issued loans to financial institutions that were hit by credit losses as a result of the recession. Those loans were then used by the financial institutions to buy treasury securities from the same credit-troubled governments.
Or, as I explained in my book (p. 109), of the €633 billion that financial institutions spent on buying treasury securities in 2010-2012, €392 billion was invested in securities from four of the five most credit-troubled governments in Europe.
Banks that are already losing money because their private-sector borrowers are defaulting on loans do not buy debt from governments with bad credit. The only exception is if they can pay for those treasury securities with loans that the ECB gives them on conditions that are as close to cash handouts as they legally can be.
This is exactly what the ECB did. Since then, all the way through the 2020 pandemic, the central bank has made supporting troubled governments its top priority. Now, when all indicators show that a new recession is here, the ECB firmly declares that it is not going to waver on its inflation target.
The firmness of the ECB’s statement, especially in the form of the emphasized sentence at the end of the quote above, should be taken seriously by euro zone governments. It means three things:
- So long as inflation is not back to 2%, the ECB will keep its interest rates where they are today;
- It does not matter if the euro zone economy combines elevated inflation with rising unemployment—low inflation remains the priority, which means high interest rates;
- If governments with big budget deficits can’t sell their treasury securities on the open market, the ECB is not going to cut its rates to help them.
To reinforce this message, the ECB’s March 7th announcement also explains that it will continue to reduce the size of its two programs for support of ‘troubled assets.’ The Asset Purchase Programme, APP, which includes government securities,
is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.
Likewise, the ECB is slowly decreasing its Pandemic Emergency Purchase Programme, PEPP, and—which is the really important point here—will continue to do so.
There is nothing in their announcement that suggests they would, under any circumstances, return to buying large amounts of government debt. It is also difficult to see how they could possibly walk away from this firm inflation policy target and start monetizing deficits again without losing all their credibility as a reliable monetary authority.
To buy government debt, namely, requires printing more money, which by necessity forces interest rates down. The lower rates make it cheaper for governments to rely on deficits for their funding, while the extra money printed by the central bank drives up inflation as it works its way through the government budget.
In conclusion, the ECB has now put all governments in the euro zone on notice: if you continue to run budget deficits, you are on your own.
