Hello, Europe? Stop Raising Interest Rates
The European Central Bank recently made a serious policy error of which the U.S. Federal Reserve Bank should take note. It raised interest rates to support a weakening euro and combat a potential rise in inflation. In the process, the ECB sacrificed growth, hurt entrepreneurs, slowed innovation, and probably undermined the euro even further. ECB Chairman William F. Duisenberg just doesn't get it. Europe needs a new central banker more in tune with the New Economy.
Capital is flooding out of Europe into U.S. stocks and direct investments in American companies. The flow has little to do with interest-rate differentials. The U.S. is growing faster than Europe because its information-based economy is more productive, innovative, and profitable. By raising rates, Duisenberg slows growth and hurts Europe's budding high-tech industry. The Neuer Markt, Germany's once-thriving Nasdaq-like capital market, is struggling. Higher rates also hurt investment in information technologies by European corporations. In 1999, IT investment was only 4.2% of gross domestic product, compared with 6.8% in the U.S.
Inflation is always a serious threat, but at 2.2% in Europe, it remains mild despite oil price hikes. Indeed, the price raises act like a huge tax on Europe, slowing growth. The ECB should end its obsession with the weak euro and concentrate on encouraging New Economy growth.
There is a lesson here for Washington. The U.S. may face a sharp decline in the dollar in the near future. The Fed can now see what happens when central bankers, like old generals, fight tomorrow's battles with yesterday's strategies.