During the crisis, interest rates fell worldwide to levels not seen in decades. Or even never seen before, as is the case with negative interest rates in Europe or Japan. Monetary policy played a prominent role among the various policy options authorities used to combat deflation risks and support economic growth. In contrast to the uniform approach in the early years of the crisis, discrepancies in the actions of major central banks have recently been observed. This reflects the different stages of the economic cycle of the economies they represent and differentiating factors such as the pace of potential growth or the need to persevere in creating a single capital market in Europe to diversify financial risk.
The ECB argues that monetary policy management must be guided by patience, persistence, and prudence. And its president, Mario Draghi, reinforces these messages of confidence in future financial stability by acknowledging that the expected monetary normalization will not lead to a deterioration of financial conditions. Monetary normalization does not kill growth. In fact, the withdrawal of unnecessary stimuli reinforces expectations of sustainable growth and eliminates potential risks that may arise from artificially maintaining these measures over time. These measures were approved in an exceptional situation that has now been overcome.
Financial markets thrive on expectations. And having flat or even inverted yield curves raises difficult questions at a time of economic expansion like the present. On the one hand, zero or even negative real interest rates in the medium and long term may indicate a deterioration of economic agents’ confidence in the future. They may also be influenced by the existence of structural factors such as demographics or low global productivity. Or perhaps they simply reflect the lack of monetary normalization by central banks, which includes excessively low official interest rates or the prolonged purchase of assets in the market. Perhaps in the end, the answer to these questions is a combination of all the above factors, something that should concern both our monetary and political authorities, as it highlights the lack of structural reforms.
A limited increase in official interest rates that impacts the rest of the yield curve upwards signifies economic agents’ validation that economic recovery is sustainable. The slope of the yield curve thus offers as much information about the economic future as the level of official interest rates themselves. And it is much more relevant in terms of financial conditions when considering the volumes traded.
Normalizing monetary policy is gradually becoming a priority, though always ensuring it is compatible with the degree of accommodation the situation requires. Communication will be key in the monetary normalization process, given that financial markets have become a source of vulnerability, as President Draghi acknowledges. Other factors threatening financial stability are trade protectionism and emerging markets.
In a scenario with so many uncertainties, what is truly important is to have a sound and solvent banking sector capable of continuing to finance economic growth even in situations of economic and financial stress. The necessary monetary normalization would strengthen banking stability.
