Some people say that there is “no healthy collateral” after the crisis, while others say that banks are hit and own a lot of overvalued assets (which won’t allow the normalization of their lending activity). Neither demand nor offer are flexible regarding the interest rate.
Central banks keep interest rates low because there is a “liquidity trap”: people, when facing uncertainty, prefer liquidity to return with risk. The ultimate proof that there is such liquidity trap is the relentless drop in inflation despite the really low interest rates on the liability component. If central banks increased the liability rates, then “adiós.”
Those who want to see an increase of the yield curve and thus more territory for speculation and arbitration, only have to wait for the real investment to be relaunched. Then, credit demand will return and rates on assets will raise. And when all this becomes sustainable for a sufficient period so as to threat inflation again, only then will central banks raise their own rates –not a second before.
The ECB is committed to deepen its fight agaisnt deflation, but it’s being criticised for being hesitant in taking action. It would be suicidal to increase rates right now. If the ECB is going to do something, it will acquire long-term assets so as to lower long-term interest rates.
If the spread between the rates of assets and liabilities is not normal is because we are in deflation, and while the end of the credit string is not unleashed, nothing will be normal. However, the other end of the string (i.e. the central bank) is not the culprit for such abnormality. On the contrary: it is doing as much as possible in order to increase the credit demand.
The problem is tightening the rear end of the string, that is, boosting productive investment. According to monetarists, this will come naturally together wih the monetary policy.
According to Keynesians, that is not enough because it would only be “pushing the first end of the string” –as the stagnation of 7 years ago shows. They say that governments should “help money getting to the markets” by redirecting the public expenditure to restore investment, employment and investor confidence. That is, “pulling from the last end of the string.”
In a crisis such as this one, the government has wide room for manoevre: to rescue banks, for instance, something that in Spain was made in half.
The government must act fast, especially when the behaviour of private citizens worsens the situation. If creditors are committed to collect their debts but debtors can’t pay because their finance and assets have dropped, then it is difficult to imagine a spontaneous and generalised action for the renegotiation of the debts.
Those actions are welcome, but won’t be enough and will negatively impact on third parties. Governments must confront the rigidity of markets to help the fulfillment of financial contracts by means of the “monetary illusion:” they must maintain a positive inflation rate, relaunching the demand as soon as possible, and allowing the devaluation of the exchange rate so as to hel the external adjustment.