By Belgian MEP Johan Van Overtveldt (Belgian Finance Minister between 2014 and 2018, Chairman of the European Parliament’s Budget Committee)
The fear of monetary tightening significantly slowing the economy is overdone. Counting on monetary and fiscal policy to do the heavy lifting in sustaining and driving economic growth is becoming increasingly illusory — and even counterproductive. More than ever, monetary policy should focus on price stability. Full stop.
In my latest blog, I argued that, in order to contain rising inflation and keep inflation expectations well anchored, the European Central Bank (ECB) should not wait too long before tightening monetary policy through higher policy interest rates. Many reactions to that blog emphasized the negative impact that higher interest rates could have on economic growth. Certainly, in the current environment of energy supply disruptions and heightened geopolitical uncertainty and turmoil, further downward pressure on economic growth is about the last thing the European economy — and the global economy more generally — needs.
However, the fear that monetary tightening will significantly depress economic growth appears overdone. In my view, the impact is limited, and there are other concerns — closely related to the structural growth potential of the economy — that strongly support the case for higher interest rates at this moment in time.
ECB’s Rehn Says Data Show First Sign of Stagflationary Shock https://t.co/xJEavaPFPx
— Bloomberg (@business) May 13, 2026
First, there is the evidence from the forceful tightening of monetary policy orchestrated by the ECB between September 2022 and September 2023, when the deposit rate — the ECB’s most important policy rate — was raised from 0% to 4%. At first sight, this exceptionally aggressive tightening appears to have had a significant impact on growth. A closer look at the broader context, however, substantially qualifies that conclusion.
The Covid pandemic caused a massive contraction in 2020, with euro area GDP falling by 6%. The economy then rebounded strongly once the worst of the pandemic had passed: growth reached 6% in 2021 and 3.6% in 2022. After such a dramatic recovery in economic activity, it was inevitable that the euro area economy would slow again toward its structural growth rate, estimated at somewhere between 1% and 1.5%. And that is exactly what happened: growth slowed to 0.4% in 2023 before recovering to 0.9% in 2024 and 1.4% last year.
Based solely on these growth figures, it may seem obvious that monetary tightening and the economic slowdown were closely linked. But this is not necessarily the case, for the simple reason that monetary policy affects the real economy only with a considerable time lag. Estimates vary, but roughly one year is generally considered a realistic benchmark. This suggests that the full impact of the ECB’s severe tightening cycle would only have been felt toward the end of 2023, given that interest rate increases began in earnest in September 2022.
If tighter monetary policy had truly been the main force pushing the economy downward, the effects should have been most visible in the growth data for 2024 and 2025. Yet the opposite occurred: the euro area economy weakened sharply before the effects of tighter monetary policy had fully filtered through, and then recovered precisely when those effects were supposed to be at their strongest.
Regime Change
The period of aggressive ECB tightening between September 2022 and September 2023, and its surprisingly limited impact on the real economy, provides substantial evidence for the thesis that a regime change has occurred in the main drivers of the business cycle. This thesis has emerged in recent years from an extensive research program at the Bank for International Settlements (BIS), led by Claudio Borio, who headed the BIS Monetary and Economic Department until 31 December 2024.
The BIS thesis essentially argues that business cycles in industrialized economies are no longer driven primarily by changes in monetary policy, but increasingly by the buildup and unwinding of financial imbalances. The financial meltdown of 2008 and its devastating impact on the real economy provide a clear illustration of this dynamic.
The ECB has signaled it will consider raising rates on June 11 https://t.co/bXJYdMIATd
— Bloomberg (@business) May 12, 2026
The pattern of the euro area business cycle during the first half of the 2020s broadly confirms the BIS model. The sharp contraction caused by the Covid-19 pandemic was followed by an equally sharp rebound in activity. This rebound was certainly helped by extremely accommodative monetary policy, but it was driven above all by the release of massive pent-up demand among consumers. After such an extraordinary surge in activity, a substantial slowdown was inevitable. Once this adjustment process had run its course, the euro area economy returned to growth rates close to its estimated potential growth rate of 1% to 1.5%.
The regime change in the Western business cycle identified by BIS researchers has profound implications for monetary policy. In particular, what are often described as the unintended consequences of monetary policy should occupy a much more central place in policymaking than they currently do.
First and foremost, low interest rates encourage excessive borrowing and rising leverage throughout the financial and economic system. According to the IIF Global Debt Monitor of February 2026, global debt — public and private combined — not only peaked during the Covid-19 pandemic, but has since risen even further, reaching a historically unprecedented 308% of global GDP. Government debt worldwide is now at levels not seen since the Napoleonic Wars of the early nineteenth century. The more debt accumulates throughout the system, and the greater the leverage, the more pronounced financial imbalances become — and the greater the risk that even a partial unwinding of those imbalances will negatively affect economic growth.
Second, there is the phenomenon of zombie companies. First identified during Japan’s prolonged period of economic stagnation — despite relentless fiscal and monetary stimulus — zombie companies are firms that can survive only in an environment of extremely low interest rates. Under normal financing conditions, their debt burdens would force them out of business. Some estimates suggest that as many as 15% of corporate entities in the West display zombie-like characteristics. This means that vast amounts of capital and labor remain trapped in unproductive firms instead of being redirected toward more innovative and profitable activities. The process of creative destruction, which lies at the heart of genuine economic progress, is severely undermined by the zombie phenomenon — itself largely a consequence of persistently low interest rates.
Last but not least, expansionary monetary policy has important consequences for wealth inequality. Persistently low interest rates encourage investors to search for yield. Capital increasingly flows into stocks and bonds, benefiting those who already own financial assets, while cautious savers who keep their money in savings accounts fall behind. Wealth inequality rises, increasing social tensions and undermining social cohesion — hardly conditions conducive to stable economic progress.
Moreover, the search for yield also fuels demand for a range of more exotic — and generally riskier — investments, including art, cryptocurrencies, and other speculative assets. This further increases the fragility of the financial system. Once again, the eventual unwinding of such imbalances tends to damage economic growth.
To conclude: monetary policy remains one of the most powerful tools of economic policymaking. More than ever — and especially in light of the regime change in the dynamics of the business cycle — monetary policy should focus on price stability. Full stop.
Originally published on the blog of Johan Van Overtveldt.
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