Monday, March 10, 2003

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Why So Small?

Those of us brought up on the humour of Mel Brooks and Blazing Saddles may feel constained by propriety from putting this most obvious of questions to Mr Duisenberg. The Economist, however, has no such reticence. I would say they have got the worst of both worlds, and that this is a result of decision by committee. You get the inevitable compromise. Either they should have followed Greenspans earlier more daring example, and made a bigger cut, or they should have waited to see if there is to be a war, and then cut dramatically. This way they waste amunition, have little meaningful effect and then have limited capacity down river. Talk about wasting your options. but I guess that just about sums up the noble history of the ECB: wasted options and missed opportunities. Meanwhile they are always at the ready to 'act decisively'.

WHY so small? That is the question many economists and businesses were asking after the announcement by the European Central Bank (ECB) on March 6th that it was lowering interest rates by a quarter of a percentage point. With the ECB’s benchmark rate now down to 2.5%, European interest rates are at their lowest level for more than three years. But the modest reduction came as the Swiss National Bank cut rates by half a percentage point. It will not silence the critics who believe that the ECB has moved too slowly to ease monetary policy.

This time, at least, the euro area’s central bank cannot be accused of trying to catch people out. The latest cut—the first since a 0.5% reduction last December—was widely expected after heavy hints from Wim Duisenberg, the president of the ECB, and some of his colleagues. Given the ECB’s longstanding reluctance to reduce rates, few seriously expected a larger cut, however much they might have hoped for it. But just as the bank is showing signs of improved communications skills, it has opened itself to the accusation that the substance of its policy is misguided.For all the moans, many economists reckon that, until recently, the ECB had managed European monetary policy rather better than its critics were willing to acknowledge. There has long been a gap between what the bank has said and what it has done. Thus the ECB’s repeated emphasis on the need to meet its inflation target—below 2%—has often been at odds with decisions to reduce interest rates when inflation was above target. In fact, prices have been rising faster than the target rate for more than half of the ECB’s existence. That has not stopped the bank from reducing interest rates in the past—even if the cuts have not been as frequent or as large as those made by the Federal Reserve, America’s central bank.

Central bankers always find themselves juggling priorities, even when, as in the ECB’s case, they have a clearly defined mandate to focus on a single policy objective. The Fed is legally obliged to worry about growth as well as inflation. The ECB is supposed only to ensure price stability as defined by its own governing board. In practice, though, the ECB has shown itself ready to act for other reasons: in September 2001, for instance, it joined the Fed in cutting interest rates in an effort to restore confidence to the financial markets. Public comments from Mr Duisenberg and other ECB officials have underlined how concerned they are about sluggish growth in the euro area—though speaking after this week’s rate cut, Mr Duisenberg said the main driving force for recovery would have to be a restoration of confidence. He made it clear that the ECB stood ready to “act decisively” if global uncertainty made that necessary.

But the context in which the ECB takes its decisions is rather different to that in which the Fed operates—and that, say the critics, is one of the problems. The ECB is a supranational organisation. Mindful of the problems that could result from exposing differences among national members of the governing board, the ECB prefers to operate by consensus.
Source: The Economist

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