One tool that can be used by the ECB to guide monetary policy is the interest rate tool. But when interest rates are around zero, people prefer to keep their money in their pockets, says monetary economics professor Casper de Vries of the Erasmus School of Economics. “The tool has therefore become blunted, because you can’t get interest rates too far below zero.”
Bonds
According to De Vries, there is another way out, namely the purchase of all kinds of bonds. ‘The ECB has done this on a large scale. Now that interest rates are on the rise again, the central bank wants to tighten,’ says the professor. The question is whether the contraction and expansion are in equilibrium. ECB economist Isabel Schnabel says it turned out to be symmetrical.
De Vries does not share this opinion: “Both instruments – thus both the interest rate and the bonds – work in tandem, which is slightly different from the other way around.” According to De Vries, it can cause surprises if the two instruments are not well tuned to each other. “The two are mutually reinforcing.”
The ECB is in the process of raising interest rates due to rising inflation. The sale of bonds held by the central bank pushes interest rates even higher. “Selling bonds also has a long-term impact and that can cause quite a few imbalances in the bond market,” fears De Vries.
‘Interest rate market totally disrupted’
According to De Vries, what happened in the UK last autumn is an example of a totally disrupted interest rate market. ‘The then Prime Minister Truss wanted to write a bad check and then interest rates soared. Many pension funds had not hedged against increases in interest rates, only against decreases. At a time like this, you need to put in an extra margin,’ explains De Vries. “Monetary policy and fiscal policy were absolutely out of sync.”
“Could cause problems in the bond market”
The professor believes that the ECB should therefore be careful about the sale of bonds. “It could just be that interest rates and bonds will work against each other and cause problems in the bond market.”