Wednesday, May 25, 2005

Crisis Looming At The ECB?

A right royal row is brewing at the ECB. Basically the old guard theorists of the 'one size fits all' monetary policy are being challenged by more pragmatic observers of day to day realities. For the moments it is the politicians who are making the running (but there are plenty of competent economists in Germany and Italy who are ready to back them up), and yesterday the OECD joined the fray.

"Wolfgang Clement, Germany's economics and labour minister, supported the OECD's conclusions about Europe, joining Italian ministers in urging the ECB to loosen monetary policy."

At the other end there is eg Erkki Liikanen:

"In an interview in today's Financial Times, Erkki Liikanen, governor of the Bank of Finland and a member of the ECB's governing council, reiterated the ECB's view that the next move in European rates would be up."

Or you have the theorist of the old guard over at the ECB Otmar Issing:

"European Central Bank chief economist Otmar Issing said euro zone growth differentials have to be addressed by national economic policies rather than by the ECB's interest rate policy."

In fact Issing is really digging in. He provocatively gave this One Size Fits All speech on 20 May. His conclusions were as follows:

"Let me conclude with a citation. On the eve of the changeover, I wrote a commentary on diversity and monetary policy in the euro area. To the question whether a single one-size monetary policy could fit all parties involved ? be they national entities, social partners or economic actors ? my answer was: ?One size must fit all?. The political decision on the creation of EMU had resolved all discussions on whether monetary union should precede or follow political unity and the fulfilment of the criteria for an optimum currency area. Today, in light of the evidence gathered so far in the euro area, I am more confident in saying: ?One size does fit all!?"

Obviously you have to ask whether Issing in now losing his grip on reality. Can one size fit all is a legitimate question, one size must fit all is not an adequate response, and one size *does* fit all seems to reflect a distorted vision of reality to say the least. Clearly Issing has a lot personally at stake in the euro process, but obviously, as we can see from political life, inability to reform and address real life issues normally leads to even bigger changes later. My feeling is that it will not be long before heads will roll at the ECB.

As the FT notes:

"The ECB has insisted that a rate cut would be harmful and was not supported by sensible economists. Jean-Claude Trichet, the ECB president, told the European Parliament on Monday: ?The last time we met, we were absolutely convinced that we would not improve the situation [with a rate cut] but that we would hamper Europe if we would go in the direction that is suggested by some.?

But now that the OECD, a bastion of orthodox economic thought, has flatly contradicted the ECB's position, Mr Trichet will find it more difficult in future to reject out of hand a discussion of lower rates."

I don't know if I count as a sensible economist or not, but this situation has long been clear to me. Personally I welcome the prospect of a new broom sweeps clean over in Frankfurt. This problem has been obvious for a long time, and it is better to address it sooner rather than later.

Update : Just to give us a measure of who is and who isn't considered a 'sensible economist', one might look at today's statement from Hans-Werner Sinn, President of Germany's prestigious Ifo index: he is reported as telling CNBC that: "the ECB has done a good last year in keeping interest rates stable, ?but we have a different situation now and the ECB should cut interest rates?.

This situation is not without its comic aspect: Sinn means sense, ie he is the real, true to life, sensible economist.

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