The Tug of War Between Central Banks, Investors, and Capital Flights

Thus, interest rates play a fundamental role as tools of monetary policy, used by central banks as a reference to regulate economic activity and control inflation. These rates represent the cost of money, determining the price at which banks can lend funds for a certain period. When central banks adjust interest rates, they influence lending and deposit rates across the entire economy, impacting not only consumption but also investment, inflation, and exchange rates. During inflationary periods, monetary authorities may choose to raise interest rates to discourage immediate consumption, favouring the postponement of purchases for the future. This reduces current demand and can lead to a rebalancing of the demand curve, resulting in a slowdown in price increases (disinflation) or even a decrease in prices (deflation).

Like central banks, investors play a significant role in the economy when it comes to lending to businesses and individuals. Thus, compared to banks, investors can offer lower interest rates due to a lower operating cost environment and less stringent regulations. Additionally, investors may be willing to accept slightly lower returns in exchange for less bureaucracy and greater flexibility in loan terms. This dynamic creates opportunities for investors to provide capital at competitive interest rates while still generating attractive returns on their investments. 

However, at a time when the aim is to decrease interest rates, the central bank must be extra cautious about the potential emergence of a phenomenon known as capital flight. Capital flight involves movements of large amounts of financial capital out of a country or region and into other locations. Focusing on the current reality, the European Central Bank (ECB) indicated at its last meeting (April 11, 2024) that it may start cutting interest rates as early as June of the same year. This decrease is motivated by the disinflation that has begun to occur in Europe. There have even been months of disinflation in Europe, as seen in November 2023 and January 2024. As for the American case, the Federal Reserve (FED), responsible for US monetary policy, did not indicate such positive data on containing inflation.

However, alongside the ECB, it promises three cuts by the end of the year. Experts indicate that, in the case of the ECB, this estimate is possible to occur, but in the American case, the certainty lies in only one cut.
Therefore, what these estimates indicate is that we may be on the verge of a possible capital flight. If inflation in Europe continues to be controlled, according to Christine Lagarde, the interest rate will be reduced. If this happens and policy is not balanced with the US, what will be observed is indeed capital flight, an extremely dangerous event for Europe. We know that the continent is already behind in technological evolution due to long bureaucratic processes and high tax burdens, confirming the saying “While the US creates, Europe regulates”. In the United States, the business environment favours innovation and entrepreneurship, with more flexible regulations that allow for the rapid introduction of new technologies and business models, facilitating adaptation to market changes. On the other hand, in Europe, regulations are more cautious and focused on protecting consumers, the environment, and workers’ rights, resulting in higher standards in areas such as food safety, data protection, and the environment. In my opinion, this fact leads to a situation where, in a possible capital flight, there is no return of the same and new liberal policies will have to be applied in Europe, policies which are long-term, leading to even greater delays in progress. If there is a desire to keep Europe “more for the people,” Christine Lagarde has to do what her predecessors did… Wait for the Fed’s rate cut and only then take a position, not the other way around.