The underlying reason why the euro zone’s monetary policy is ineffective: Lower risk-free interest rates have been offset by higher risk premia

T he euro zone’s monetary policy has been highly expansionary since 2014 . And yet corporate investment remains quite weak, equity valuation remains depressed and growth is slowing: the effectiveness of the expansionary monetary policy seems to be limited, despite the fall in the cost of debt. We propose the following explanation: while risk-free interest rates have fallen considerably, risk premia have risen considerably also . Altogether, the required return on risky assets (corporate capital, equities) has not fallen, which explains the lack of monetary policy effectiveness. The rise in actual or perceived risk has cancelled out the stimulatory effect of the expansionary monetary policy.