Medicine More Deadly than Disease?

The question arises as to what the central banks are achieving in combating the Covid recession. Are the means suitable or even counterproductive? The analysis by Tilmann Galler, Capital Market Strategies at J.P. Morgan Asset Management, shows that the price, asset and currency effects of monetary policy incentives are positive in the long term. The income, confidence and expectation effects are negative.

Six general transmission mechanisms were investigated. With lower interest rates, these influence demand within the economy, which leads to cheaper credit. Consumption is also strengthened by the wealth effect, as lower interest rates boost investment prices and thus the development of wealth. Not to be forgotten is the currency effect, which favours an increase in exports and a reduction in imports. Slow growth, and thus low real interest rates in the long term, is likely to result from the easing of monetary policy.

The result could therefore be an inflation of the central banks’ balance sheets, which, however, will not strengthen the global economy but rather weaken it in the long term. The income effect would also be negative. With lower interest rates, the income of savers is potentially reduced more than the cost of credit is simultaneously reduced. The confidence effect and the concerns of consumers and businesses are also added when a central bank is forced to lower interest rates to support the economy.

Not forgetting the expectation effect, where borrowers assume that today’s rate cuts will cause interest rates to fall further and wait for even lower rates before borrowing. Therefore, if there are fears of a recession, large spending or borrowing is expected, Galler said.

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