After announcing the fourth cut of 0.25 points in official interest rates in the eurozone, up to 3%, the last question at the press conference by the president of the European Central Bank (ECB), Christine Lagarde, definitively opened the big melon in the background of the monetary institution: whether the rate floor is below the reference level of 2%.
“There have been very different opinions, expressed by different members [del consejo de gobierno]that there is still a lot of room or no room” until reaching the “neutral interest rate […]. What is your opinion?”, launched a journalist.
“I think it’s a question we’ll probably debate more and more as we get closer to where it ultimately is. […] The general opinion is that it is a little higher than before, for multiple reasons. The numbers that were indicated in the last calculation by the ECB economists gave a range of 1.75% to 2.5%”, Lagarde replied..
Just four days later, on Monday, December 16, in a speech in Lithuania, the president of the ECB recalled that the roadmap is to “continue lowering interest rates.” This will deepen the path of falls that the Euribor, the reference for variable mortgages, has experienced in recent months, which has closed 2024 with the largest decrease since 2012 and is at its lowest level since September 2022.
As knowledgeable sources have confirmed to elDiario.es, for the year that now begins, in the calendar of the organization chaired by Lagarde there are four more cuts in the official price of money of a quarter of a point each in the coming months, until leaving them at 2%.
What is not certain is whether this is the floor for this cycle of easing financing conditions after the strong increases approved to contain the inflationary bleeding caused by the invasion of Ukraine. There are doubts about whether that ground will be lower. And that is where the debate about “the neutral interest rate” comes in, the philosopher’s stone of monetary policy.
On the same Monday that Lagarde confirmed that she will continue lowering rates in 2025, Germany’s voice on the ECB’s executive committee, Isabel Schnabel, gave her own version of this balance level – technically known as R* -, in a speech given in Paris (France)and titled: “Navigating towards neutrality.”
Schnabel said: “There is no consensus on what its main determinants are or how best to estimate it. Consequently, the range of estimates is exceptionally wide, both within and between models. […]. A recent analysis by ECB staff [el mismo que citó Lagarde] suggests that the point estimate of R* ranges between approximately -0.5% and 1%, or between 1.5% and 3% in nominal terms [teniendo en cuenta una inflación en el objetivo teórico del 2%]”.
Why have Lagarde, Schnabel and other members of the governing council decided to talk about this abstract concept on which they do not even agree? And what exactly does this R* or neutral interest rate mean? “It is the equilibrium interest rate, which neither accelerates nor slows down the economy. And that occurs when activity is growing at full capacity and inflation is stable,” Judith Arnal, researcher at the Center for European Policy Studies (CEPS) and the Elcano Royal Institute, explains to elDiario.es.
“It represents the equilibrium real interest rate compatible with full employment and stable inflation in an economy. It is a key concept of monetary policy, which helps central banks determine the appropriate level of interest rates to achieve their medium and long-term price stability objectives,” the AFI analysis team observes in a report.
“It would be defined as that level that would not generate perverse incentives or imbalances. There are as many neutral interest rates as there are points of view. Furthermore, any level of interest rate is going to affect the economy, so none is neutral,” comments economist Eduardo Garzón. “That level is an absolutely subjective construct,” he continues. “It is not observable,” agrees Judith Arnal.
“As we get closer to price stability, we are going to talk about long-term equilibrium,” continues this economist. The problem with this last mile – again, in monetary jargon – of moderating inflation to the 2% target is that economic activity in Germany is stagnant, while in France the fiscal problems increase, by not having the deficit (the imbalance between public income and expenditure) or the increase in debt. These two countries account for close to half of the eurozone’s total GDP.
In this context, an expansionary monetary policy, which aimed to promote growth, the creation of jobs, investments and the reduction of imbalances, should place official interest rates below the neutral interest rate, if there is a way. to calculate it.
Uncertainties for neutrality
In the medium and long term, financing needs also appear for the digital transition, for the fight against climate change, for the reduction of inequality or to address the aging of the population and productivity, in a very complicated geopolitical context and facing the threat that Donald Trump’s return to the White House will trigger a trade war. Some factors are inflationary and others are not. In other words, some pull interest rates down and others up.
Among the factors that can cause deflation (general drops in prices) is the possibility of a trade war between the United States and China with the imposition of new tariffs. As the president of the Central Bank of the Netherlands and member of the Governing Council of the ECB, Klaas Noot, warned a few days ago, “there is a possibility that the Chinese will begin to offer their products in Europe at increasingly lower prices”, something that “it is already happening in the steel market.”
Meanwhile, the Federal Reserve (Fed) of the United States cut interest rates for the third time last Wednesday by 0.25 points, to 4.5%, after doing so another quarter of a point in November and, before, lowering them in September. half a point hit due to the moderation of inflation. However, it has increased its forecast to 2.5% on average in 2025, from 2.1% previously.
The Fed’s own new roadmap for interest rate cuts in the coming months now points to only two more cuts of 0.25 points, which would leave the reference rate at 4%. The ECB is conditioned by the Federal Reserve because if a large gap opens between the rates of the eurozone and those of the United States, a depreciation of the euro could occur with respect to the inflationary dollar (for the eurozone): automatically imports of oil and Other raw materials or products that are traded in dollars would become more expensive due to the effect of the exchange rate.
Within the ECB, the fact that Schnabel sees the balance in a wider range than Lagarde may reflect that the former is more concerned about uncertainties, although ideologically her position and that of Germany have a bias towards tight control of inflation, despite to the suffocation of families and companies. In fact, the weakness of the eurozone locomotive is conditioning this debate.
On the other hand, Eduardo Garzón recalls that “lately we have seen that economies like Japan or China maintain interest rates close to 0% for a long time while Western economies have had them much higher. Obviously it is the result of different political positions, there is nothing neutral.” As he concludes, “in fact, the supporters of Modern Monetary Theory want the interest rate to be 0%, because in this way those who already have money are not rewarded and those who lack it are not penalized.”
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