The ECB’s interest rate policy is counterproductive for growth
According to the Bank for International Settlements (BIS), the
share of ‘zombie’ firms in the major industrialised countries has
been steadily increasing since the 1980s. Under normal market
conditions, these firms would disappear and make way for
fundamentally more productive and profitable ones. In the
literature, poor financial health of the banking sector and the low
interest rate policy of central banks are cited as two important
reasons for the survival of these ‘zombie’ firms. Said firms crowd
out lending for investment by more productive firms, and thus weigh
on productivity and employment growth. A first step by the ECB
towards interest rate normalisation in the near future would
therefore enhance the growth potential of the euro area economy.
More and more ‘zombie’ firms
Recent research by the Bank for International Settlements (BIS) shows
that the share of so-called ‘zombie’ firms in 14 major industrialised
countries has been steadily increasing since the end of the 1980s.
Under normal market conditions, these firms would disappear and make
way for structurally profitable and more sustainable firms.
The ECB, the OECD and the BIS, among others, have recently carried
out research on this subject. It suggests that the poor financial
health of the banking sector, e.g. measured by the
Price-to-Book-ratio, is an important potential explanation of why such
‘zombie’ firms can survive (see Figure 1).
Figure 1 - Financial health of banking sector important determinant for share of ‘zombie’ firms (in percent)
Financially weak banks have an incentive not to acknowledge or
write-off problematic loans if this would jeopardise the banks’
capital ratios. The problematic loans are often refinanced on a
recurring basis, seemingly without any visible negative impact on the
banks’ balance sheets. As part of the solution to this specific
problem, a recent ECB report stresses the importance of efficient
bankruptcy laws, which facilitate corporate restructuring. This would
make it easier for structurally non-viable companies to leave the
market in favour of more productive ones.
Monetary policy is part of the problem
In addition, the ECB’s current ultra-accommodative monetary policy
encourages the continuation of loans to ‘zombie’ firms - loans which
could not be financed at a more ‘normal’ rate of interest (see Figure
Figure 2 - Low interest rate boosts ‘zombie’ share (in percent)
These ‘zombie’ loans partly replace the financing of investments by
more productive companies, which disrupts the efficient allocation of
capital. The BIS therefore warns that this weighs on macroeconomic
investment and productivity growth and on employment. OECD research
supports this conclusion. The BIS also states that, since the Great
Financial Crisis, monetary policy has contributed to the structural
decline of potential real GDP growth in most OECD countries.
‘Zombies’ in the public sector
The market-distorting effects of extreme low interest rate policies
are reflected not only in the private sector, but also in yield
spreads between euro area government bonds (see Figure 3).
Figure 3 - Euro area public finances on life support by ECB (10 year government bond yield spreads, in percentage points)
Like the credit risk premium for ‘zombie’ firms, these government
bond yield spreads no longer reflect the underlying economic reality,
including the true credit risk. The most extreme example is the Greek
10-year government bond yield, which at present only offers a risk
premium of 3.4 percentage points above the German Bund yield. The fact
that this risk premium is highly artificial becomes clear when we
consider that Greece had a gross public debt of 183% of GDP in 2018,
which was only sustainable because a large part of that debt is held
by other euro area governments. By keeping the cost of financing
public debt artificially low, monetary policy reduces the pressure on
governments to put their budgets on a sustainable path.
More normal interest rates would boost growth
Through its unconventional monetary policy, the ECB has undoubtedly
saved the European economy from a deeper recession following the Great
Financial Crisis. Since then, however, the undesirable side effects
have gradually outweighed the benefits. In order to boost investment,
employment and, ultimately, inflation, the ECB should therefore start
normalising its policy interest rates as soon as possible. Not only
does an unchanged policy stance hardly contribute to achieving the
ECB’s inflation target (see KBC
Economic Opinion of 30 April 2019), it also undermines the
growth potential of the European economy.