Article published by José Alberto León Alonso in Diario de Avisos on 06/15/14.
The European Central Bank (ECB) has lowered interest rates to 0.15%, has set a negative rate (-0.1%) on bank deposits and, above all, has announced an open liquidity bar of 400,000 million euros for banks conditional on increasing their exposure to credit to families and companies. The big question is whether these measures will serve to stimulate the economy. My opinion is that they will serve no purpose other than increasing speculation in the stock market and sovereign debt markets. Because? Because we are in a liquidity trap.
The concept of liquidity trap, originally defined by Keynes, one of the greatest economists in history and the one who postulated the way out of the Great Depression of the 1930s through public spending and investment, is used to define an economic situation in which monetary policy becomes inefficient to stimulate investment and consumption. Once the Central Bank has reduced the interest rate to practically 0% (as now), no matter how much additional money it injects into the economy, the effect is null and monetary policy becomes useless to stimulate economic activity. This happens because in this situation people prefer to keep the money rather than invest it, since the almost zero cost of money (the low interest rate) does not encourage taking risks. Thus, the monetary mass grows but does not circulate, and neither growth nor inflation occurs. For Keynes, monetary policy is like a rope in the hands of the governors of the central banks: they can pull it by raising the price of money and curbing economic excesses, but it is difficult to push that rope, that is, using monetary policy to boost the economy. Keynes himself considered the liquidity trap a theoretical curiosity of little importance. However, when the Japanese economy fell into a period of prolonged stagnation with near-zero interest rates in the early 1990s, the concept of a liquidity trap came back to the fore, as Japan's expansionary monetary policy proved futile over the next 20 years. In the current crisis, the Nobel Prize winner in Economics Paul Krugman repeatedly argued that between 2008 and 2012 the United States, Europe and Japan were in a liquidity trap, and monetary policy was useless, as demonstrated by the fact that, for example, money in circulation had multiplied by three in the United States between 2008 and 2011 without producing any significant effect on prices or significantly reducing unemployment.
The solution that Keynes (and Krugman) gives to the liquidity trap is an expansive fiscal policy, in which GDP and employment are stimulated through increased public spending, but in times of depression like the current one, in which the state is in deficit and with a considerable accumulated debt, it does not seem that public spending can be increased much further. What would be the solution then? In my opinion, the most logical thing would be a public investment package at the European level. Given that the states cannot further increase public spending on their own, the ECB should inject those 400 billion euros, but not in credits, but in investments in infrastructure through the European Investment Bank (EIB). Of course, in the infrastructure necessary to free the European economy from constraints on its growth. Not in building sidewalks like our disastrous Plan E, nor in building empty airports. Fortunately, in Europe, a series of infrastructures necessary to stimulate growth, with enormous potential for benefit, have long been identified. If that money were used to accelerate them, we would not only stimulate current growth, but future growth, and we would get out of the liquidity trap and, with a little luck, with some inflation.
Instead, we give money to banks to lend, but in economics as important as how is when, and this measure comes late. If it had been taken six years ago, when banks canceled overnight the lines of credit that they maintained even though they were solid companies, it would have allowed the survival of many solvent companies in the long term but with short-term liquidity problems. And the credit could have been a temporary solution to a liquidity crisis like the one suffered by the majority of Spanish companies at the beginning of the crisis. But it was not done at the time, and a good part of the solvent companies but with liquidity problems disappeared along the way. Now those that remain do not need money from the banks to survive, and have adapted (by reducing size and staff) to living without loans while they focus on repaying everything they still owe. If we add to this that the banks themselves are in a process of recapitalization and debt reduction to comply with the demanding solvency requirements of Basel III, which requires a greater amount of capital for the same level of loans, and that the purchase of public debt by banks continues to be favored, since it is still considered that it does not consume own resources, while any type of loan does, we will conclude that the effects of the new ECB policy will focus solely on the field of the economy. financial, and not the real economy: the stock market will rise and the risk premium of sovereign debt will fall. Given that liquidity injections remove the threat of default from the countries in the worst situation (those in southern Europe), it is most likely that the risk premium between the countries of the north and those on the periphery will continue to close. And the fall in the profitability of sovereign debt will displace speculators towards equities. In fact, that is what is happening. The stock markets have risen almost 6% in a week and the cost of Spanish debt is now the lowest in history. Is there any real reason for this? None. It's pure speculation. Simply the abundance of liquidity generating bubbles in the markets. In the past, this excess liquidity was directed towards housing credit, and now towards debt and the stock market. But we already know that bubbles burst when least expected.
