The ECB’s interest rate increases have subtracted 2.5 points from Spain’s growth in the last three years

The interest rate increases of the European Central Bank (ECB) have subtracted 2.5 points from Spain’s growth in the last three years, and will still continue to hit the growth of GDP (Gross Domestic Producer) in 2025. The Bank of Spain estimates that the damage from monetary austerity to the real economy will reach close to 40 billion euros in total from 2022 to 2025.

Meanwhile, the institution led by José Luis Escrivá points out that the “tightening” of financing conditions has barely reduced the average inflation each year by a few tenths, but celebrates that it has been “fundamental in anchoring expectations” regarding price increases.

The general director of Economy of the Bank of Spain, Ángel Gavilán, included these conclusions in a conference titled “Monetary policy: where do we come from? Where are we? and where are we going?” which he gave this Friday at the ‘Alicante Conference on Spanish Economy’. According to their calculations, the increases in the official ‘price’ of money that the ECB began in June 2022 to fight inflation subtracted half a point from the growth of economic activity in 2022, in full recovery from the shock of the pandemic, just over one point in 2023 and almost another point in 2024, as can be seen in the graph extracted from Gavilán’s own presentation.

Central banks assume the damage to the real economy (to families, to companies…) as part of their strategy to fight inflation. Monetary austerity is effectively a way of suffocating household demand and companies’ ability to invest by making mortgages and loans in general more expensive. In the 2022 annual report, the Bank of Spain noted “the transmission channels” of interest rate increases, as seen in the table. Of all of them, the “intertemporal substitution effect”, which refers to “the contraction of spending” due to the increase in the ‘price’ of money, has been the main blow to the economy. The next was “the income effect”. Or, what is the same, “the contraction of spending” in this case due to “the decline” in the income of families or companies.

According to the Bank of Spain’s own scheme, increases in interest rates will continue to damage “demand” in the coming months, although in July 2024 the ECB decided to begin retracing monetary austerity with a first cut, which was followed another in September and another in October, up to the current 3.25%. These drops do not prevent interest rates from being much higher now than two years ago. Starting in 2022, the organization chaired by Christine Lagarde began an aggressive policy of increases from -0.5%, which was the main reference, to taking them to 4% just over a year ago.

During this time, inflation has moderated to even remain below the theoretical target of 2%, mainly due to the fall in energy prices, which were the cause of the crisis after the Russian invasion of Ukraine along with the bottlenecks. in world trade that caused the emergence of the pandemic since 2021. The Bank of Spain’s own figures barely give any impact to monetary austerity.

Of course, the institution highlights that the “decided reaction” of the central banks on a global scale “was essential to avoid an unanchoring of inflation expectations in the medium term that would have entailed, through second round effects via salaries and surpluses.” [beneficios empresariales]a cost on economic activity much higher than that observed.” That is to say, the Bank of Spain reiterates the thesis that a scenario without monetary austerity would have been much more impoverishing than it has been with it.

Trump is a new threat

At the moment, the ECB is easing financing conditions given the moderation of inflation in the eurozone as a whole and to breathe oxygen into the economy, especially due to the stagnation in Germany and the weakness of growth in France. The United States Federal Reserve (Fed) is also doing it. Although there is a new threat there, the return of Donald Trump to the White House.

In his previous stage as president of the world’s leading economy, he already ignored the supposed independence of monetary policy and publicly pressured the institution. Additionally, Trump has promised to slap widespread tariffs on American imports and cut taxes on everything from corporate profits to overtime pay. Policies that are inflationary.

From our point of view (that of Spain and the eurozone), the ECB is conditioned by the Federal Reserve because if a large gap opens between the rates of the eurozone and the United States, a depreciation of the euro could occur with respect to the inflationary dollar. (for the eurozone), because imports of oil and other raw materials or products that are traded in dollars would automatically become more expensive due to the effect of the exchange rate.

Lagarde’s roadmap for the coming months is to decide “meeting by meeting” of her Government Council, and as she has repeated ad nauseam, with “dependence on the data.” Looking to a more distant future, Gavilán incorporated a dose of self-criticism in his conference: “In the coming years, supply shocks could be more frequent and persistent than in recent decades—due, for example, to climate change, technological advances and geopolitical conflicts—and the economy, on a global scale, could have a lower capacity to absorb them,” he said. “This will represent a challenge for monetary policy, which will have to deepen the analysis of the nature and degree of persistence of the disturbances, and weigh the ‘trade-off’ that exists between activity and inflation when supply shocks materialize – unlike of what happens with demand shocks […]—”, he concluded.