ECB’s Holzmann Warns of Monetary Policy Consequences if r* Decline Not Reversed

15 September, 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Robert Holzmann on Wednesday warned of the monetary policy and economic consequences if the downward trend of the equilibrium real interest rate r* were not reversed.

In a speech at a virtual workshop, Holzmann, who heads the Austrian National Bank, said that if the trend were not corrected, ‘the policy space for central banks will remain limited and economic perspectives dim’ and ‘[c]entral banks might have to extend current or implement new unconventional monetary policy instruments.’

He rejected the idea that fiscal policy could compensate thanks to low interest rates, arguing that eventual rate hikes could lead to a sovereign debt crisis and that the reasons for the decline of r* were per se ‘a matter of concern since they cast a shadow on future living standards.’

While fiscal policy was better able than monetary policy to boost growth and productivity, those countries needing the required support could have the least room to manoeuvre, he said.

Holzmann proposed mitigating the impact of ageing populations on r* by increasing retirement ages and labour market participation rates.

While possible that monetary policy does not affect r*, ‘[t]here are good reasons to hypothesize that r* actually is endogenous with respect to monetary policy, in other words, monetary policy itself affects r*’, he said.

However, ‘one should at least raise serious doubts about’ the likelihood of monetary policy affecting r* positively, he said. ‘In fact, although monetary policy has been highly accommodative for many years, we have not seen an increase in inflation, nor in productivity and estimates of r* remain close to zero.’

As for accommodative monetary policy having negative effects on r*, this was unclear, he said. ‘We could thus be doing more harm than good with an ultra-loose monetary policy if the negative effects dominate’, he said, calling for additional research on the subject.

‘In the meantime, we should err on the side of caution, recognize the limitations of monetary policy, take potential real and financial side effects very seriously, and focus our attention on other policy areas to raise r*’, he said.