ZEW Economist Friedrich Heinemann on ECB Interest Rate Decision

“The Alleged Dilemma Does Not Exist if the ECB Takes Its Mandate Seriously” (April 2022)

The ECB Governing Council has still not specified a date for a first interest rate hike. Despite record inflation in the eurozone, the deposit facility rate remains negative. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at ZEW Mannheim, has commented on this matter:

“The ECB claims to be in a dilemma because it is simultaneously confronted with high inflation and the threat of a war-related recession. In this situation the members of the ECB Governing Council are advised to simply take a look at the European treaties. There they will find a clear answer as to how the ECB should behave in such a situation: Since price stability is the primary objective, other objectives must be subordinated to it. The alleged dilemma does not exist if the ECB takes its mandate seriously. With every month of hesitating, the ECB Governing Council is damaging the reputation of this important European institution. A series of massively wrong inflation forecasts by ECB economists also feeds the suspicion that the assessment of inflation dynamics is driven by the desire to maintain a low interest rate policy and not, conversely, that interest rate policy is based on an undistorted inflation forecast.”

“The War Will Have a Longer-Term Inflationary Effect” (March 2022)

The ECB Governing Council has held out the prospect of putting an end to bond purchases in September if forecasts do not point to a slowdown in inflation. The end of the purchases is seen as a prerequisite for a first subsequent interest rate hike. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at ZEW Mannheim, has commented on this matter:

“The war in Ukraine has massively raised uncertainty about the economic development of the eurozone. Two weeks after the outbreak of war, it is impossible to predict to what extent the conflict will dampen the recovery of the economy. It is understandable that the ECB is still taking some time before initiating the change in monetary policy. However, the Russian invasion of Ukraine has ultimately made the necessary change all the more pressing. The renewed rise in energy prices will further fuel inflation in the short term. Even more important for monetary policy are the inflation processes that have been triggered. The accelerated restructuring of the energy supply will be costly and drive prices up for years to come. Moreover, in the forthcoming bargaining rounds, unlike last year, the unions can no longer afford to simply ignore the currently witnessed very sharp decline in the purchasing power of wages. The war will have a longer-term inflationary effect, and the Governing Council must soon find a convincing solution to this threat.”

“ECB Risks Damaging Its Reputation” (January 2022)

The ECB Governing Council has not yet initiated any measures to tighten its monetary policy in January 2022 despite the persistently high inflation in the eurozone. Professor Friedrich Heinemann, head of the research area "Corporate Taxation and Public Finance" at ZEW Mannheim, has commented on this matter:

“The ECB’s interest rate policy and bond purchases now appear to be very much out of date. Europe’s central bank is still pursuing a policy of fighting deflation, even though Europe is experiencing the strongest surge in inflation since the introduction of the euro and inflation expectations are rising. The Governing Council now risks seriously damaging the ECB’s reputation. More and more monetary policy observers are wondering whether price stability is still the ECB’s top priority. With the rigid adherence to an extremely loose policy despite this surprisingly prolonged high inflation, the suspicion is growing that a majority of the ECB’s Governing Council is driven by entirely different goals, such as the easy financing of high government deficits. It is high time that the ECB proves that it is not trapped in fiscal dominance.”

“Meloni’s Criticism Must Make the ECB Even More Determined” (October 2022)

The ECB Governing Council has decided on a major interest rate hike again and raised the key interest rate by 75 basis points. The interest rate on the main refinancing operations of banks is now at 2.0 per cent. Professor Friedrich Heinemann, head of the Research Unit “Corporate Taxation and Public Finance” at ZEW Mannheim, has commented on this matter:

“This second major interest rate hike was inevitable. Unlike the Fed, the ECB failed to turn its interest rate policy around in time. In view of record inflation, the ECB must now move away from its inappropriately low key interest rates as quickly as possible. This course of action is also supported by the members of the ECB Governing Council who were previously considered doves. But the most controversial debates are probably still ahead of the Council next year. High inflation and, in particular, increased inflation expectations call for higher interest rates, which could reach the four per cent mark in the course of 2023. Handling the energy recession and concerns about the debt sustainability of southern European states require a more cautious approach. In her first government statement, Italy’s new Prime Minister Giorgia Meloni called the ECB’s interest rate hikes ‘a rash choice’. Her criticism will most likely have exactly the opposite effect of what she had in mind. If the political pressure to pursue a permanently loose monetary policy becomes this evident in times of high inflation, this must make the ECB even more determined in its fight against inflation.”

"The ECB Must Curb Inflation Expectations" (21.07.2022)

Due to high inflation in the eurozone, the ECB Governing Council decided on an interest-rate hike of 50 basis points. In addition, the ECB introduced a “transmission protection instrument”. Professor Friedrich Heinemann, head of the Research Unit “Corporate Taxation and Public Finance” at ZEW Mannheim, has commented on this matter:

“It is a good thing that the ECB Governing Council has finally decided on a dramatic interest rate hike. The inflation rate is not expected to return to its target range any time soon. Moreover, the extremely high consumer price inflation is gradually leading to wage inflation, which will further accelerate the wage-price spiral. Under these circumstances, the ECB Governing Council finally had to show its determination to curb inflation expectations. While the interest rate decision is a step in the right direction, the new transmission protection instrument carries some potential dangers. The ECB is increasingly turning into an authority with the power to decide on the financiability of high sovereign debt and thus also on the fate of governments. This is not compatible with the monetary policy task of an independent central bank.”

The ECB Governing Council has decided to end asset purchases at the end of June, clearing the way for a first interest rate hike in July. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at ZEW Mannheim, has commented on this matter:

“The end of the asset purchases was overdue and comes at least three months too late. Looking back at monetary policy in recent years, a strong asymmetry becomes apparent. If inflation was too low, the ECB always acted quickly using all available means to fight it. By contrast, Europe’s central bank has been very slow to counteract the currently far too high inflation. One explanation for the ECB’s eagerness to act when price increases are low and its passivity when inflation is too high can be found in the euro government bond market: The prospect of a cautious turnaround in monetary policy already pushed the Italy’s bond spread back up to over 200 basis points. The fear of a new euro debt crisis is still paralysing the ECB and damaging its credibility. The fact that the eurozone has not yet found a credible strategy for dealing with heavily indebted states is now taking its toll.”