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Economy

Opinion: No magic formula to tackle deflation

The European Central Bank faces problems no matter what it does, as it is administering untested medicine to patients with completely different symptoms, says DW's Rolf Wenkel.

Seldom has it been so easy for the German commentariat to rant against a monetary policy decision of the European Central Bank. They find themselves in illustrious company. Leading representatives of the country's savings banks, local cooperative banks, the insurance industry and most economic research institutes warned the ECB against lowering interest rates even further. That leads us down a dangerous path, was the unanimous opinion.

The new historically low interest rate of 0.15 percent amounts to nothing less than the dispossession of European savers, they argue, because interest paid on deposits will be eaten up by inflation. If this state of affairs persists, the threat of huge gaps in funded pensions will loom. Insurers can simply no longer generate the interest income they had promised their customers for their retirement.

It's no accident that German lobbyists are among the loudest complainers. It is precisely the Germans who continue to conservatively entrust their money to savings accounts, which at present yield essentially nothing - at an inflation rate of 1.1 percent in April. But the ECB isn't thinking about Germans when it makes its decisions on interest rates. There are 17 other countries that use the euro, and many of them are in poor shape. The French economy, the second-largest in the eurozone, is stagnant; in Italy, Finland, the Netherlands, Portugal, Cyprus and Greece the economy is shrinking even further.

"We are not resigned to allowing inflation to remain too low for too long," ECB chief Mario Draghi said not long ago in Sintra, Portugal, where almost all the monetary policy-makers in the world were assembled. In policy terms, Draghi intends to prevent potential deflation - a fall in prices leading to stagnation - and stimulate the economy in the eurozone's southern periphery.

The question remains as to whether this will really achieve anything. Experts agree that cutting the base rate by a further 0.1 percentage points produces virtually no additional economic stimulus. European monetary policy cannot replace national economic policy. And it is far from clear to economists that the ECB needs to fight against supposedly imminent deflation. Only in Portugal, Cyprus, Slovakia and Greece are prices and wages falling. And that can also be interpreted as a process of correction, as they take the rocky road back to greater competitiveness.

On the other hand, what is completely new and untested is the medicine of penalty interest for banks when they park their money at the central bank instead of passing it on to the economy in the form of loans. It is clear what Draghi wants: While in Germany just one in 100 medium-sized companies is complaining about stingy banks, in Spain around one quarter of all business face financing problems - and in Portugal, that's even one third.

Again, the idea here is to help the south, while in the north, at best, this provides no benefit. That's because banks could get the idea of holding central bank money only in the amount of the statutory reserve - the bare minimum they are required to. Since each additional parked euro costs penalty interest, they will not hold any more excess liquidity. But this will lead to a shortage of funds in the interbank market. It could threaten the return of the famous credit crunch as it did during the global financial crisis of 2008.

There are three lessons to be learned from the ECB's plan to help the eurozone's problematic south. First: It has no magic formula that could provide the same beneficial results everywhere. This can be seen, secondly, in the exchange rate: Shortly after the Governing Council meeting, the euro fell by a cent or so against the dollar. But if the D-mark had still existed, it would have leapt in value, while drachma, peseta, lira and escudo would have depreciated just as dramatically. The economic situation of the eurozone countries is too different for a monetary policy decision alone to put everything right.

Third, and perhaps worst of all: as the ECB struggles to get out of the frying pan, it's looking into the fire. The historically low interest rates make it increasingly difficult to generate adequate returns - including for banks whose focus is the unglamorous business of making loans and managing their customers' deposits. Continuing weak earnings could entice banks to accept higher risks and forming new bubbles - exactly the opposite effect of what a central bank actually wants.