- The European Central Bank (ECB) looks as though it will stay on the course of loose monetary policy in the coming months.
- Germany's insurance and banking sectors will suffer as a result, whipping up anti-ECB sentiment among German voters.
- The frustration of German voters will increase friction between Germany and the ECB.
The ECB is gearing up to hold its first monetary policy meeting since bank President Mario Draghi announced a new package of measures that included more quantitative easing and an interest cut that will push rates, already in the negatives, even lower. During the April 21 meeting, Draghi will probably address concerns raised by German Finance Minister Wolfgang Schaeuble that loose ECB policies created and fueled the rise of the German opposition party Alternative for Germany (AfD). As Schaeuble's statements highlight, the relationship between Germany and the ECB is antagonistic — and it is going to get worse.
Because the eurozone lacks a unified fiscal institution for its central bank, the ECB, to collaborate with, the bank plays more of a political role than peer institutions such as the U.S. Federal Reserve do. Unlike the Fed, the ECB has to balance the competing demands of the national economies under its jurisdiction. Aiding one country's economy often means harming another's.
Northern European countries such as Germany have historically preferred a tighter monetary policy so as to control inflation. Southern European countries such as Italy, by contrast, are more accustomed to looser monetary policy and to the economic stimulation that follows. Their confrontation over monetary policy has snowballed since the beginning of the global financial crisis, and the ECB is stuck in the middle.
Broadly speaking, the ECB has been loosening monetary policy since 2011 and at an accelerated pace since 2014. Interest rates first entered negative territory during summer 2014. That August, Draghi began hinting that he would pursue quantitative easing. In January 2015, he followed through on the easing program despite German objections. Moreover, in the second half of 2014, oil prices bottomed out at $50 per barrel from a high that year of $100 per barrel. In August 2014, the popularity of the AfD, a group of economists who opposed the euro, also dramatically increased. All of these developments were linked.
The continuing lack of inflation motivated Draghi's loose monetary policies. The official ECB target for inflation is 2 percent, and Draghi has repeatedly called meeting this target his primary concern. When eurozone inflation dropped from 1.5 percent to 0.5 percent in the first half of 2014, Draghi felt compelled to act. The dramatic drops in the price of oil increased his sense of urgency, especially by January 2015, when inflation hit minus 0.5 percent — at which point he pulled the trigger on quantitative easing.
A Win for the South, a Worry for the North
These developments have been mostly positive for Southern Europe. The ECB's easy-money policies have driven down the interest rates that governments must pay on debt, providing increased budgetary flexibility in countries such as Italy, Spain and Portugal that are weighed down by high debt loads. Meanwhile, low oil prices have stimulated consumption, which helped each to post improved growth figures. (From 2014 to 2015, Italian growth grew from minus 0.4 percent to 0.8 percent, Spanish from 1.4 percent to 3.2 percent and Portuguese from 0.9 percent to 1.5 percent.) But so far, this consumption-led growth has had only a minimal effect on these countries' debt, which continued to grow as a percentage of gross domestic product in Italy and Spain and was only slightly reduced in Portugal. (From 2014 to 2015, debt as a percentage of GDP grew from 132.3 percent to 132.8 percent in Italy and from 99.3 percent to 100.7 percent in Spain, and it dropped from 130.2 percent to 129.1 percent in Portugal.)
All of this troubles Northern Europe, particularly Germany. Berlin fears that low interest rates are reducing the pressure on Southern Europeans to enact broad economic reforms. In Germany's view, low oil prices are giving southern economies the semblance of growth reminiscent of the first decade of this century, when high consumption temporarily boosted growth while also creating the circumstances for the 2008-2012 crises. It is because of these crises that southern countries have the debt they still hold. Germany fears that if things do not change, southern debt will ultimately have to be paid down with German money.
Southern spending is not the only consequence of ECB policy that worries Germany: The bank's policies also directly harm Germany, especially its financial sector. One major loser is the German life insurance sector. Given that the proportion of Germany's population moving toward old age is among the largest in Europe, life insurance is big business in Germany, and insurers have extended generous offers to policyholders. To ensure they can pay out their customers' life insurance policies, the insurers must earn a minimum 5 percent return on their investments. But in the present low-yield environment, quantitative easing has helped drive the yields on "risk-free" assets such as German 10-year government bonds down to 0.1 percent. This means that German life insurance companies would have to make risky investments to achieve a 5 percent return, something they most likely will not do. Instead, German insurers' investments will become less profitable over time as higher-yielding assets bought before the beginning of the current low-yield environment mature and are replaced with assets purchased in today's low-yield environment. The head of insurance supervision at BaFin, the German supervisory authority, has said that, as things stand, he can be certain of the sector's safety only until 2018. Smaller German insurers will bear the brunt of the problem, since larger international players have the option of turning abroad for more profitable investments.
The German banking sector will also feel the impact of ECB policy. Though economists are still studying the relatively new phenomenon of negative interest rates, the rates will certainly affect the banking sector. Most traditional bank profits come from the difference between the interest rate that banks charge their customers and the rate the central bank offers the banks to hold money overnight. (Investments offer other avenues for profits, but here the banks run up against the same lower-yield problems that the insurance companies face.) But when the central bank's rates enter negative territory and it charges banks to hold money, the banks have proved unwilling to pass that cost on to customers. The banks fear that depositors will withdraw their money in favor of the proverbial mattress, cutting even further into bank profits. This is obviously a problem for all European banks, but German financial institutions are particularly vulnerable because their market is so competitive. Competition has already driven bank margins lower than in other countries. Therefore, the profitability of German banks is particularly hurt whenever the ECB drops its rates.
Insurance and banking profits aside, there are profound cultural reasons that Germans have objected to ECB policy. Germany famously suffered a scarring experience with hyperinflation in the 1920s that is often linked to the rise of the Nazis. Academic and media circles have said the next step will be the ECB's use of what is called "helicopter money," money printed by the central bank and then distributed directly to the European public. This would be distinct from quantitative easing, when the central bank predominantly buys government bonds. Buying bonds gives the policy a built-in expiration date: When the bonds reach maturity, they disappear. Helicopter money, by contrast, creates funds that do not automatically vanish. Though such a plan is a long way from realization, increased discussion of helicopter money alone has increased anti-ECB sentiment in Germany.
The ECB looks set to continue its policy of loose money given that eurozone inflation is at 0 percent, low oil prices are unlikely to rise significantly any time soon and the depreciation of various major currencies has pushed the euro upward. Germans will probably grow only more uncomfortable with ECB policy over time. The open question in Germany, then, is which party will best harness these anti-ECB feelings.
Founded in 2013 as an anti-euro party, the AfD was hobbled by infighting in 2015. It emerged from the conflict with a more anti-immigrant focus, which has proved a popular platform; the party performed well in state elections in March and is now polling at 13 percent nationally. If it can also tap into its anti-euro roots, the AfD could conceivably take advantage of popular anger at ECB policy and the refugee crisis to become a major force in German politics.
If it cannot, another possible candidate for political gains is the venerable, liberal Free Democratic Party. It lost numerous supporters to the AfD in 2013-14 but has been bouncing back in polls over the past few months.
The party will face competition from the center-left Social Democratic Party, which, despite its ideology, has sought to tap into anger at the ECB. The Social Democrats have experienced an identity crisis after years of participating in a government coalition with the conservatives; criticism of the ECB may strike party leaders as a plausible way to appeal to discontented voters. Either way, the Christian Democratic Union and the Christian Social Union — the senior coalition partners — will have to adjust to the political winds. With 2017 general elections coming up, both parties are acutely aware of the threat the AfD poses and will strive to defuse it while siphoning off the maximum number of voters focused on those issues. However Draghi chooses to address Germany's politicians at the ECB meeting, the next year will likely see growing tension between the ECB and the European Union's largest member state.