by
Antony Mueller
The
international financial system is in intensive care. The system is kept alive
through massive transfusions of liquidity. Central banks in the United States,
Europe and Japan have opened the floodgates of financial liquidity in order to
keep the system alive in its state of emergency. How long can it go on? For
years by now, interest rates have been at zero bound. Since the early 1990s,
Japan has tried to stimulate its economy through easy money and public
spending. At the inception of the current crisis, the United States have joined
and more recently Europe, too, has begun to slash interest rates down close to
zero. Yet like in Japan, in the United States and in Europe, the prime
instruments of monetary and fiscal policy no longer work. What has been going
on?
One main
reason why the traditional instruments of monetary and fiscal policy no longer
work is the fact that public debt has reached levels that are unsustainable.
The more governments fight against stagnation, the more they produce the very
obstacle against growth because of rising debt. In the meantime monetary policy
has brought down interest rates to zero bound. While this seems to be fine for
financial market, it also means that there is no longer room for expectations
of a further decline of interest rates.
Where do we
go from here? Central banks try as hard as they can to keep interest rates low.
Any significant rise of the real interest rate would bring governments closer
to default. There is no room left for central banks to lower nominal interest
rates. There is only one way out of this dilemma in the perspective of the
major central banks: price inflation. Nevertheless, inflation rates remain
stubbornly low in the major economies. Central banks still face a nightmare:
deflation with the consequence of sharply rising real interest rates which
would not only bring many companies down and lead to higher unemployment, deflation
would also mean that governments themselves are threatened by default.
