High inflation protects us for now from a new euro crisis

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In economic circles, there are fears here and there of a new euro crisis, while it has been decided that Greece no longer needs to be supervised by the EU. Southern Eurozone countries could face difficulties due to an interest rate hike by the European Central Bank (ECB). However, experts tell NU.nl that the risk of another crisis is low, thanks to high inflation.

What’s going on?

The ECB announced two weeks ago that the key rate would drop next month from -0.50 to -0.25%. This means that banks still have to pay interest on the money they deposit with the ECB. If you deposit money into your bank’s account, the bank then deposits it into an ECB account. They then use it to invest in the economy.

In September, the ECB interest rate will rise to at least 0%, but it could also be higher, depending on the economic situation at the time. From then on, the banks will again earn on the money they store at the ECB.

Most economists are happy with these interest rate hikes because if the ECB raises interest rates, eventually the regular banks will too. And the higher the interest rate, the more people earn from their savings and the longer they will stay there. We will then spend less and inflation will decrease.

But such a rise in interest rates also has drawbacks. For example, it will become more expensive to pay off mortgage debt, but government debt will also become more expensive. And in recent years, countries have borrowed heavily to cope with the corona crisis.

For a country like the Netherlands, this is not such a big problem, because our cash flow can handle it. But Italy or Spain are already struggling with a mountain of high debt and their budgets are much less balanced. Higher interest rates therefore make it more difficult for them to repay their debts.

Haven’t we seen this before?

Yes of course. In 2009, Greece threatened to go bankrupt, even if it was not linked to an increase in interest rates. The country’s budget deficit turned out to be larger than expected due to the credit crunch that started a year earlier. As a result, other eurozone countries had to deleverage Greece, threatening to drag the entire eurozone into the Greek trap.

In the end, we didn’t come to that, but Greece was placed under EU supervision. The country had to cut spending to get financial support. Now, more than ten years later, Greece is on top and surveillance will be lifted in August.

How does the ECB intend to solve the current problem?

The ECB has yet to unveil the exact plans, but the central bank was quick to call a meeting last week to discuss the matter.

Economists assume a mechanism similar to that of Greece. “The ECB will probably buy government bonds from southern euro countries, but in line with demands for reform,” says ING economist Carsten Brzeski. Government bonds are country debts that are “bought” by another party, but then have to be repaid with interest. So it’s a kind of loan.

During the previous crisis, the ECB introduced an instrument called OMT. In principle, this allows the bank to buy an unlimited number of bonds from a country that requests them, but these purchases are subject to strict conditions. The OMT has never been used since its introduction. That could now change.

The bank has yet to answer an important question, according to Brzeski. To determine if a country is in trouble, the ECB looks at the bond yields of a stable country, such as Germany, and compares them to the interest rates of the other country. The difference between them is the so-called spread. The wider the spread, the more problematic it is. “But the ECB has yet to say when the gap is too wide. So it’s unclear when exactly the bank will step in.”

What is the ECB doing?

  • The main task of the ECB is to keep inflation under control in the countries of the euro zone. In addition, since 2014 the ECB also monitors all banks in the euro zone and ensures that banks can deposit their money somewhere.
  • In recent years, the central bank has become best known for its asset purchase programs. Since the credit crisis, the ECB has bought up public debt en masse to inject new money into the economy and stimulate investment. This in turn is good for economic growth. During the corona crisis, the ECB launched a similar program.
  • Both of these programs will be completed this year, after which interest rates will rise again.

Will the countries have to be saved again as soon as 2009?

Economists do not immediately expect a real euro crisis. “The ECB will do everything in its power to prevent this,” says Roel Beetsma, a professor at the University of Amsterdam.

Moreover, high inflation currently means that a country’s bankruptcy is not imminent. “The higher the inflation, the more revenue governments have. And with interest on their debt still very low, that’s the perfect combination,” Brzeski said. Beetsma agrees, but nuances that problems could arise if inflation is soon significantly lower and interest rates rise sharply.

We should therefore not expect any problems at the moment, but it is important for the ECB to keep the pulse. “After all, the Greek drama proved that investors can suddenly be scared and unwilling to lend money to a country overnight. The ECB should be wary of that,” Beetsma says.

But by tackling problems before they arise, the central bank sends a clear signal to financial markets that it has the situation under control and that a new crisis can be postponed for as long as possible, agree the two experts .

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