Whereas in the past the European Central Bank focused mainly on easing monetary policy, nowadays there is talk of tightening. Professor of Monetary Economics Casper de Vries believes that the ECB should proceed with caution: ‘Fiscal policy and monetary policy must remain in balance.’
An instrument that can be used by the ECB to steer monetary policy is the interest rate instrument. But when interest rates are around zero, people prefer to keep their money in their pockets, says Professor of Monetary Economics Casper de Vries of the Erasmus School of Economics. ‘The instrument has then become blunt, because you cannot bring interest rates too far below zero.’
According to De Vries, there is another way out, namely buying up all kinds of bonds. ‘The ECB has done that on a large scale. Now that interest rates are rising again, the central bank wants to tighten,’ says the professor. The question is whether the contraction and expansion are in balance with each other. Economist Isabel Schnabel of the ECB says that it turned out symmetrically.
De Vries does not share this opinion: ‘Both instruments – so 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 properly tuned to each other. “The two reinforce each other.”
The ECB is in the process of raising interest rates because of rising inflation. The sale of the bonds held by the central bank pushes interest rates even higher. ‘Selling the bonds also has an impact in the long term and that can cause quite a few imbalances in the bond market’, De Vries fears.
‘Totally disrupted interest rate market’
According to De Vries, what happened in the United Kingdom 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 shot up. Many pension funds had not hedged against interest rate rises, only against falls. At such a moment, extra margin has to be put in,’ explains De Vries. “Monetary policy and fiscal policy were absolutely out of sync.”
The professor believes that the ECB should therefore be careful with the sale of the bonds. “It could just be that interest rates and bonds will work against each other and cause problems in the bond market.”