Reduced Interest Rate and Inflation Rate - Assignment Example

The European Central Bank identifies interest rates as an important determinant for financial and investment growth and sustainability. In the article, therefore, Mario Draghi hints at the bank’s decision to on a short term to medium term basis revise its interest rate further down. According to the report, there is the consideration of keeping the interest rate low “but its policymakers had decided to keep the main refinancing rate on hold for the fifth consecutive month” (Steen, 2013). Among other things, the report admits the influence of high-interest rates on other economic determinants such as inflation and foreign direct investment. It, therefore, sees the ambition of the European Central Bank to keep its interest rate at record low values as an attempt to redeem the European region from the further financial crisis, admitting that as it stands now, “the eurozone lurches out of recession amid high unemployment and low growth” (Steen, 2013). In this analysis paper, the economic implications of the decision taken by the European Central Bank are further analyzed in relation to key arguments made in the report.

Influence of reduced interest rate on the inflation rate

There are some key indicators within the article to suggest that the lowered interest rates within the eurozone over the years have not necessarily sent inflation levels to the target of the European Central Bank. The writer however generally, opines that using inflation rates in August and September, which were 1.3 percent and 1.1 percent respectively, the intended intervention by the European Central Bank could become a one-stop strategy to achieve low inflation. Clearly, there is the enthusiasm with inflation coming down because once they do it would mean that prices can be expected to be relatively stable, ensuring that consumers have sufficient reserves in their purchasing power. However, the analogy presented in the report cannot be wholly true that reduced interest rates will forever stabilize or reduce inflation. This is because, from the theory of rational expectations, the current hypothesis may only be short-lived as investors are likely to start switching to the use of real interest rates in the determination of prices as begin to project inflation in the future (Bernanke, 2006).

External determinants of growth

In the article, there is the admission that the eurozone is not independent of itself in the determination of factors that will bring general economic relief to its populace and for that matter, investors. This is because the reference is made to the US budget shutdown with the assertion that “US budget shutdown would represent a risk to the world economy if it were protracted” (Steen, 2013). The implication of this admission is that no single trade and economic region is independent of itself in the regulation of its monetary policies. As much as possible, it is always important to have an eye for what is happening in other sectors and regions of trade and economic activities. This is because the world is now put in a position where the global economic market is more vibrant in the determination of growth for individual markets than individual markets can determine for the global economic market (Bernanke, 2006). Even within the eurozone alone, the graph below shows that even though different member states have different interest rates, it is the collection of the differences that constitute a holistic rate determinant for the larger region.

Steen (2013)

Impact of excess liquidity on financial fragmentation

The issue of real interest rates that were raised earlier is trumpeted in the latter parts of the report as the president of the European Central Bank admits that bank liquidity is a challenge for the use of lowered interest rates to being about economic revamping. This is because, in his opinion, bank liquidity cannot be predicted perfectly on its impact on “the real economy in the form of lending to companies” (Steen, 2013). This is an important aspect of the article and the entire interventional step being considered by the European Central Bank. The justification for this point is that sidelining the effect that other key economic indicators and variables could have on the lowered interest rates will only create a situation where the real target beneficiaries will not benefit (Gartner, 1985). This is to say that investors and entrepreneurs will continue to enjoy reduced interest rates on their loans but they will continue to keep prices higher and deny ordinary consumers the need to enjoy some levels of financial leverage and freedom.

Conclusion

Several economic factors have been considered in relation to interest rate levels and thus the ambition of the European Central Bank to revamp the economic fortunes of the eurozone with reduced interest rates. Generally, it can be concluded that even though the intended initiative has very strong econometric justification and backing, it cannot serve as an end to a means. Rather, it will be worth it if the bank sees a reduction in interest rates as a means to an end. This is because, in the analysis, it was established that existing interventions of economic redemption and revival, which of course includes lower interest rates have not been successful in bringing inflation to a level desired by the bank. Therefore, any form of economic remediation that will be attempted by the stakeholders within the eurozone financial sector must be made in relation to other economically viable determinants rather than undertaking these interventions in isolation.