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Macroeconomics

24 October 2019

CIAO MARIO 

Today Mario Draghi will preside over his last European Central Bank meeting. There is a lot to say about him and press comments range from the ‘whatever it takes’ period to the current discord in the decisive policy committee, after the latest decisions to lower interest rates and renew quantitative easing.

But perhaps the decision with the biggest impact was to push rates into negative territory. This simply turned the fixed-income logic upside down. When you’re getting paid to borrow, the traditional views regarding weighted average cost of capital and discounted cash flow methods are truly questioned. Hence the approach to capital markets is completely different.

It also explains why some companies with junk bond credit ratings manage to finance themselves below 1%. It also creates so-called zombie companies, companies which would have gone bust if it weren’t for the extremely low financing costs. That in itself hinders creative destruction and the survival of the fittest. It has certainly also hit the European banking sector as profitability falls. And as banks in Europe are the main source of financing, unlike in the US where capital markets play a far larger role, it has not been beneficial for lending. At least, there is little evidence that negative rates have boosted credit activity. They did not boost consumption either. A good example is Germany, where the household savings rate has climbed from below 8% to above 10% in the past five years. In increasingly older societies, people feel they need to save more to guarantee their standard of living.

However, it would be unfair to see only the possibly negative ramifications of Draghi’s legacy. Without ‘Super Mario’ we might not have the euro today. And it is almost impossible to gauge what would have happened without his policies, called brinkmanship by some. Would we not have sunk into deflation? Would we not have seen a struggle for the likes of Italy to survive with its mountain-high debt pile and weakened banking landscape?

The true weakness for any given ECB president lies in the huge disparities he or she has to face when at the helm of the central bank. The right policy mix for southern Europe is completely different than for, say, Germany and the Netherlands. It looks an impossible task to satisfy all. With that in mind let’s simply say ‘Ciao Mario, grazie ed arrivederci’…