Interest rate increases by the European Central Bank (ECB) have subtracted 2.5 points from Spanish growth over the past three years and will continue to weigh on GDP (gross domestic producer) growth in 2025. The Bank of Spain estimates that the damage caused to the real economy by monetary austerity will reach a total of almost 40 billion euros between 2022 and 2025.
Furthermore, the institution headed by José Luis Escriva emphasizes that the “tightening” of financing conditions has barely reduced average inflation each year by a few tenths, but welcomes that it has been “fundamental in anchoring expectations” regarding price increases.
The general director of Economy of the Bank of Spain, Ángel Gavilán, included these conclusions in a conference entitled “Monetary policy: where do we come from?” and where are we going? which he delivered this Friday at the “Alicante Conference on the Spanish Economy”. According to their calculations, the increases in the official “price” of money that the ECB began in June 2022 to fight inflation subtracted half a point from the growth of economic activity in 2022, in full recovery of the shock of the pandemic, barely more than half a point. one point in 2023 and almost another point in 2024, as shown in the graph taken from Gavilán’s own presentation.
Central banks assume the damage caused to the real economy (to families, businesses, etc.) as part of their strategy to fight inflation. Monetary austerity is in effect a way of stifling household demand and the ability of businesses to invest by making mortgages and loans in general more expensive. In the 2022 annual report, the Bank of Spain highlighted “the transmission channels” of interest rate increases, as shown in the table. Among all these phenomena, the “intertemporal substitution effect,” which refers to the “contraction of spending” due to the increase in the “price” of currency, was the biggest blow to the economy. The next one was the “income effect”. Or, which amounts to the same thing, “the contraction of expenses” in this case due to the “decline” in family or business income.
According to the Bank of Spain’s plan, interest rate increases will continue to harm “demand” in the coming months, although in July 2024 the ECB has decided to start retracing monetary austerity with a first reduction, followed by another in September and another in October, up to the current level of 3.25%. These reductions do not prevent interest rates from being much higher today than two years ago. From 2022, the organization chaired by Christine Lagarde began an aggressive policy of increases of -0.5%, which was the main reference, to bring them to 4% a little over a year ago.
Meanwhile, inflation moderated to even remain below the theoretical target of 2%, mainly due to the fall in energy prices, which was at the origin of the crisis after the he Russian invasion of Ukraine and the resulting bottlenecks in global trade. the emergence of the pandemic since 2021. The Bank of Spain’s own figures give practically no impact on monetary austerity.
Of course, the institution emphasizes that the “decided reaction” of central banks on a global scale “was essential to avoid a de-anchoring of medium-term inflation expectations which would have resulted, through second round effects, via wages and surpluses.” [beneficios empresariales]a cost on economic activity much higher than that observed. In other words, the Bank of Spain reiterates the thesis according to which a scenario without monetary austerity would have been much more impoverishing than with it.
Trump is a new threat
For now, the ECB is easing financing conditions given the moderation of inflation across the eurozone and to breathe oxygen into the economy, particularly due to stagnation in Germany and weak growth in France. The US Federal Reserve (Fed) also does this. Even if there is a new threat there, the return of Donald Trump to the White House.
During his previous period as president of the world’s largest economy, he had already ignored the supposed independence of monetary policy and publicly pressured the institution. Additionally, Trump has promised to impose across-the-board tariffs on U.S. imports and cut taxes on everything from corporate profits to overtime. Inflationary policies.
From our point of view (that of Spain and the euro zone), the ECB is conditioned by the Federal Reserve because if a significant gap opens between the rates of the euro zone and those of the United States, a depreciation of the euro could occur against the inflationary dollar (for the eurozone), because imports of oil and other raw materials or products traded in dollars would automatically become more expensive due to the effect of the exchange rate.
Lagarde’s roadmap for the coming months is to decide “meeting by meeting” of her Governing Council, and as she has repeated ad nauseam, “based on data”. Looking to a more distant future, Gavilán incorporated a dose of self-criticism into his lecture: “In the years to come, supply shocks may be more frequent and more persistent than in recent decades – due to, e.g. , climate change, technological progress and climate change. geopolitical conflicts – and the economy, on a global scale, may have less capacity to absorb them,” he said. “This will pose a challenge for monetary policy, which will need to deepen the analysis of the nature and degree of persistence of disruptions, and weigh the ‘trade-off’ that exists between activity and inflation when supply shocks materialize – unlike what happens happens with demand shocks. […]—,” he concluded.
