Commentary: Europe's Central Bank Ought to Loosen Up
By David Fairlamb
Call it the Duisenberg shuffle. As the U.S. economic slowdown threatened to undermine Europe's growth prospects in the winter and spring, the European Central Bank, of which Wim Duisenberg is president, turned a deaf ear to calls from financial markets, economists, and politicians on both sides of the Atlantic to loosen credit. No, Duisenberg insisted, inflation was a bigger menace, and besides, Europe would resist the U.S. contagion. Unconvinced, currency traders kept the euro under pressure. Then, on May 10, the bank belatedly heeded its critics, cutting its key rate by a quarter-percentage point, to 4.5%. So what happened to demon inflation? Duisenberg explained in a press conference that a slight downward revision in money-supply figures suggested that inflation wouldn't rise over the medium term.
Small wonder traders sold the euro further on the news. It fell below 88 cents and hasn't gained much since, despite the U.S. Federal Reserve's half-point cut in the Fed Fund target rate. The ECB move looked less like a sign of better economic times than a confirmation that the bank, after three years of existence, is a weak, even capricious steward of Europe's economy. Certainly, the 12-nation euro zone needs lower rates. But the clumsy way the bank's governing council handled the decision underscores the rigidity of its monetary policymaking and its poor communication skills.
The bankers of Frankfurt had an intellectually defensible point when they stuck to their inflation line--which they did until shortly before the cut. Euro-zone consumer prices have exceeded the ECB's 2% limit for a year. April prices, released after the move, rose 2.9% year-on-year as the impact of higher energy prices, plus mad cow and foot-and-mouth disease, filtered through the economy. French, German, and Italian data suggest that the headline figure could peak at 3% by October. "That's why the markets had no longer expected a cut before summer, though evidence of weaker growth in euro-land was mounting--particularly in Germany," says Jens Dallmeyer, an economist at Deutsche Bank Research in Frankfurt.
Then, the ECB seemed to trash its own logic by trimming rates with no sign of abating inflation, catching the markets flat-footed. By suddenly focusing on the money supply, the ECB convinced investors it was casting about for an excuse to cut. Now it looks as if Duisenberg bowed to outside pressure. Insiders say that after the decision, rumors hit the currency markets that U.S. Federal Reserve Board Chairman Alan Greenspan had phoned Duisenberg to argue for looser credit. "The reduction suggests the ECB isn't living by its own rules," says Anton van Rossum, CEO of Fortis Group, the Belgian-Dutch financial-services giant.
TOO LITTLE, TOO LATE. Economists say the easing probably is too little, too late. It takes 12 to 18 months for monetary policy changes to affect the euro zone, versus six to nine months in the U.S., because of rigidity in the economy. Duisenberg's warning that the ECB would be vigilant about wages made the minimal reduction sound even more like a nod to critics. "The bank has become a victim of its own inflation and money-supply targets," says a senior French banker.
That's why an increasing number of European central bankers think the ECB should adopt a new parameter. Klaus-Dieter Kuehbacher, a member of Germany's Deutsche Bundesbank's council, says the bank should reconsider its 2% inflation target--which it has the authority to do. At 3%, it would gain flexibility without looking weak or igniting inflation.
The ECB also needs a larger sense of what credibility entails. Its real task is to create the conditions for a prosperous Europe. There's a real economy in Europe. The ECB should give it the help it needs.
Fairlamb covers European finance from Frankfurt.