Economics and politics - comment and analysis
16. October 2018 I Heiner Flassbeck I General

Why interest rates are low and Italy needs our support

Originally posted in German at Makroskop

Translated and edited by BRAVE NEW EUROPE

Some time ago, the conservative German daily newspaper Frankfurter Allgemeine Zeitung (FAZ) published a piece in which it tried to explain why interest rates are so low and why they remain so. Interestingly, a graph in the article shows that in Britain, where there was no hyperinflation even before the world wars, the key interest rate is now lower and more stable than ever in the past 150 years.

  Prime interest rate in Great Britain since 1878

The graph also shows that interest rates in Britain from 1878 to the end of the Second World War were generally very low and the central bank only changed these relatively slightly (more or less between 2 and 6 percent). It was only after the Second World War – more precisely after 1970 – that a phase began (all over the world) in which interest rates rose sharply and fluctuated considerably.

From inflation to deflation

The latter phenomena, was , of course the period in which the world experienced significant inflation in the wake of full employment and the oil price shocks, and in which most of the world’s central banks tried to combat the dangers of inflation with “monetarism”, i.e. the control of a money supply. This failed egregiously, but in the wake of the restrictive policies of the central banks (interest rates were raised dramatically despite the risk of recession in the wake of the oil price increases) unemployment rose considerably almost everywhere and trade unions were put on the defensive, which finally led to falling wage increases, unit labour costs rising less, and normalised price increases.

However, this phase came to an end at the beginning of the 1990s, and interest rates were much calmer again – until after 2009. Downward movements came to an almost complete standstill  close to the zero line. Obviously, the inflation problem was over because there was no serious attempt using economic policy to achieve full employment. With the Great Financial Crisis in 2009, the key interest rate in Britain and (a little later) in the European Monetary Union plummeted and have remained at new historical lows for almost ten years.

What is the reason for this absolute low today?

Although the FAZ pointed out in its article that in Japan the phase of historically zero interest rate has persisted for over twenty years, it does not ask what could be causing  this. This example demonstrates wonderfully the thesis that we have repeatedly put forward: that neoliberalism has finally triumphed to death. If we add the case of Japan, it is perfectly clear that it is above all the behaviour of companies that signals to the central banks to leave interest rates permanently in the doldrums.

If investment activity and the creation of new jobs were to really take off in a way that was taken for granted in the cycles of the first decades following the Second World War, the zero interest phase would immediately come to an end.

But companies, which are saving money and not investing, and politicians, paralyzed by fear, leave the central banks no choice but to extend the zero interest rate ever longer. Even in the US, where after a long period of strong government stimulus unemployment has at least been reduced significantly after a long upswing, the labour movement is so weak that it is unable to crown the cycle by demanding robust wage increases. So the key interest rate is rising, but slower and weaker than ever before.

With its phobia of public debt, Europe is putting itself in harm’s way. It obviously doesn’t (or can’t) understand that with companies saving money, only the state – no matter how high its debt level is – can ensure that the economy thrives and creates new jobs, which is what the Italian government is proposing.

What is to be done politically?

The manner in which the Italian government´s strategy to emerge from long-term recession by slightly increasing government loans (compared with 2017) is being judged in Europe says it all. On the one hand, the ECB seems to be under great political pressure not to do anything about attempts launched by the “markets” to raise Italian interest rates by selling off Italian government bonds. At the same time, the Commission itself (as in the case of Commissioner Moscovici) is opposed to the Italian plans, apparently to reassure the northern nations of the ECB´s loyalty to budget discipline.

Loudest of all is the eloquent silence of the German members of the Euro group, which is again flanked by fierce press attacks from commercial and state media with close ties to the German government.  The Berlin government apparently does not want to wake any new fears of a euro crisis in the small world where German voters dwell, especially before upcoming  state elections. After the elections, that could well change. There is no indication that the grand coalition would be prepared to take an objective view of the matter and support Italy in its perfectly legitimate cause.

A new unjustified “charge of imprudent finances” against Italy, however, is precisely the way to open the door to nationalist parties here and there. In Italy, because the nation can’t find a way out of its current crisis and the voters are increasingly turning away from Europe and becoming more radical. In Germany, because those who criticise Italy confirm the warnings of those who secretly hope that the euro will collapse. Anyone who wants to fight the AfD and save Europe must, however, be prepared to take positions that are less popular, but are completely justified from an economic standpoint . Especially those who like to accuse others of populism must then, if they have strong arguments, oppose the “populists” in order to make their own position popular.


Because I wanted to see what the AfD says about low interest rates in Europe, I took a look at their basic programme. And behold: the AfD, which once proudly called itself the Professor’s Party precisely because of the question of the euro, has just failed to understand the most important fact about the euro. It writes (on page 35) that the euro prevents the necessary balancing of different productivity developments through nominal appreciation and depreciation. That is wrong. Changes in exchange rates do not compensate for this. They merely balance out inflation differences, but never productivity differences. As I have just shown again (here), a nominal devaluation can only offset a nominal difference, but not a real one.

That is a true opportunity for the other political parties. Where is the German Minister of Finance, who now can attack the AfD head-on? Where is the German Minister of Economics, who claims to know exactly what world trade needs. None of them seem to be able to make use of the inane claims of the AfD, because even today they still have no idea what the euro is all about. They prefer to continue spreading their usual empty rhetoric and then wonder why large sections of the electorate eventually have had enough and run after those who confirm them in their simplest prejudices.