Saturday, November 08, 2003

Trichet: A Man For All Seasons?

Yesterday was a reasonably interesting day over at the MS Gloabl Forum. Eric Chaney welcomes the arrival of Jean-Claude Trichet, and in so doing makes an interesting point. The demographic changes may make for a more deflationary atmosphere. When I started saying this publicly over a year ago I felt myself to be a very lonely voice indeed. Every day now I notice more and more people who are thinking about the argument. This can only be to the good. On another angle, I do hope he's right, and that Trichet is 'pragmatic'. What a breath of fresh air that would be!

All that is good, I am often told, but since Trichet got his medals as an inflexible inflation fighter and a true believer of the virtues of a strong currency, will he be able to cope with the challenges of a deflationist world? Although nobody knows if deflation will be a permanent feature of the next eight years, the risk is still there, as the abnormally low level of inflation in the US eloquently reminds us. As far as Europe is concerned, secular demographic trends may increase the risk of deflation: After all, inflation or deflation reflect social preferences, to some extent, and the growing number of pensioners in Europe might tilt the social balance in favor of deflation. This is why a central banker must be open minded and pragmatic. I think that Jean-Claude Trichet has proved he has these qualities in two particular circumstances. First, instead of abandoning ERM rules after the 1992 crisis, he convinced his partners to make the system flexible enough to cope with future speculative tensions, by adopting a large fluctuation band. This proved successful in 1995. Second, in 1998, when financial markets thought that euro interest rates would be some kind of weighted average of member countries’ past rates, Trichet, well aware of the dangerously low level of inflation in core countries (starting with France and Germany) and convinced that averaging Italian and German rates would dilute the credibility of the euro, argued to set the initial level of interest rates at the lowest possible level (3%), despite strong opposition from some countries. This is the man who did not hesitate to push French rates to 7%, then fought to cut them to 3%; simply, times were different. I would call that pragmatism.
Source: Morgan Stanley GEF

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