Draghi: The Inflation Slayer?

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What's going on?

On Thursday, the European Central Bank (ECB) convened – nothing major was announced but there were still a few important takeaways…

What does this mean?

The ECBs President, Mario Draghi, reiterated that he is very concerned about low inflation. Low inflation is both a sign of a weak economy (people cant afford to pay higher prices for things, which means companies cant raise their prices) and a cause of further weakness (if companies cant raise their prices, theyre less likely to raise their workers wages). Low inflation also makes it more difficult for companies and governments to pay back debt think about it: if the value of money gets eroded by high inflation, then the debt that one holds becomes easier to pay back. With no inflation, that doesnt happen (and Europe has a lot of debt). Draghi said that the ECB is prepared to use all available instruments in order to boost inflation, i.e. they could cut interest rates even further into negative territory (click here for an explanation of how low interest rates can boost inflation).

Why should I care?

For you personally: Low interest rates cause people to buy riskier investments. Generally speaking, when a central bank lowers interest rates, the returns on government bonds go down. Those low returns tend to incentivize people to buy riskier investments in the hopes of achieving a suitable (in their view) return on their investments. That can create bubble-like valuations in things like stocks and real estate. Some think that if interest rates do go up, then the value of such investments could suffer quite substantially.

The bigger picture: Draghi pushed for more government spending. Central bankers have consistently said that low interest rates alone wont do the trick: governments must help stimulate their economies by spending more money to directly create jobs, e.g. by building roads and airports. As the efficacy of low interest rates wane, pressure on governments to spend more heavily to boost economic growth is likely to increase.

Originally posted as part of the Finimize daily email.

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