Reforming the Eurozone financial system: A system-dynamics approach
Year: 2024
Type: article
Abstract: In order to assess the effectiveness of the ECB’s policies on QE and raised interest rates and to explore alternatives, we developed a system-dynamics model of the EU financial system at a high level of aggregation. With endogenous money creation, the multidirectional relationship between asset prices and net income and the dual causality of both liquidity and investment relative to interest rates as key features of the model, the developments of the past 50 years can be made understandable and be extrapolated to 2050. The model results indicate that the non-standard policies which the ECB has available within its current mandate are not up to the task of maintaining price stability within the Eurozone (2 % targeted inflation). Inflation initially remained too low for a long period, after which it became so high that it then had to be controlled by interest rate policy. But in that case, however, the many positive feed-backs in the system generate a significant risk of overshooting the target and harmful economic side effects. Inherent (price-) stability of the system requires concerted countercyclical policy measures which both ease and tighten the total amount of money in the system, respectively through money creation to the real economy and interest rate adjustments. In the shorter term improvements can already be made through modest reforms that broaden the ECB’s mandate, enabling money creation alongside the current money creation by commercial banks.However, the highest stability is achieved in the event that all the money to maintain 2% inflation is created exclusively by ECB, for example as Central Bank Digital Currency. In that case the higher volume of countercyclical money creation allows for adequate dynamic control in such a way that interest policy with potential harmful effects becomes superfluous. The concerted action of a single authority in search of price stability as the sole objective will reduce the complexity of the financial system and allow for much more effective supervision.
Authors: N.D. van Egmond, B.J.M. de Vries
Institution: Utrecht University
Language: English
Domain: Social Sciences
Open Access status: hybrid
Estimated APC paid: $3,490
OpenAlex ID: W4392624364