Stephen King: ECB's chance to make the party go with a bang

'The rocket metaphor is all very well, but it would be much better applied to China than to Europe'
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The Independent Online

Imagine the situation. You decide to hold a party. You make out a guest list. You send out the invites. You book the caterers. You buy the drinks. You hire the waiters. You select the music. You do your hair.

And on the evening of the party? The clock ticks incessantly in the background. The Twiglets sit miserably in a corner. You idly flick through your CDs, looking for some musical inspiration. You have a couple of drinks to "get in the mood". But at no point does the doorbell ring. Your guests haven't turned up. The coat stand is bare. The staff leave. You eat some Twiglets. Listen to a bit of music. Pretend that you're enjoying yourself. Yet you've failed. Your evening has been an unmitigated disaster.

The European Central Bank thought it was going to host a "happening" party in the second half of 2003. It invited a large number of guests: consumers, producers, investors, exporters. All these and more were due to turn up to Europe's social event of the year. Get them in the mood, let them drop their inhibitions and the European economy would party like there was no tomorrow.

At least, that was the idea. The ECB, though, forgot about one major problem. Its previous parties had not been a success. Whether it was a lack of alcohol, the wrong kind of music or bad caterers, the ECB had never managed to throw a successful party. A few people had turned up from time to time but, on the whole, they departed early and disappointed: they'd have been better off staying at home watching the telly.

The ECB thought all this was a bit unfair. After all, interest rates were low by historical standards, suggesting that loose monetary policy - the vital ingredient for party success - was clearly in place. When he was in charge of party arrangements, Wim Duisenberg had tried to generate a bit of a vibe but, all too often, he could be found lurking in the corner of his sitting room, standing behind his makeshift bar, toying with his cocktail shaker, thinking "if only a few guests would turn up".

Of course, it's no longer Wim Duisenberg who's the master of ceremonies. That honour has fallen to Jean-Claude Trichet. When he took over, he seemed to think that a decent party was a matter of days away. After all, a lot of invitees had reason to be hopeful - they'd seen their stock market wealth recover after the battering received in 2001 and 2003, and they'd seen their exports picking up quite nicely. With interest rates very low, surely, this time, the European recovery wouldn't abort.

The ECB views the world in a fairly simple way. Take this quote from M. Trichet reported in Handelsblatt, the German business newspaper: "In the normal course of economic activity, recovery most often starts with net exports, then passes over to investment and then, as the third stage of the rocket ignites, so to speak, arrives at consumption. The first two rocket stages have ignited and we continue to follow the relevant hard data. We now have to examine very carefully the ignition process of the third stage."

The "rocket" metaphor is all very well, but it would be much better applied to China or one of the other fast-growing areas of the world, but surely not to Europe. In the eurozone's case, lighting a firework in an unstable milk bottle on a cold and rainy night would be a more apt description of a typical economic recovery. Even if the firework were to ignite, it's not likely to get very far - and, with all that rain, the chances are that ignition itself would be highly uncertain.

In any case, even if M. Trichet's metaphor is accepted, the argument is still very odd. Recovery led by exports? Investment following afterwards? Consumer spending coming through later still? Really? If recovery is led by exports, what role do domestic policymakers actually play? Does this argument not imply that the ECB, and assorted European finance ministries, are effectively saying that they have no role to play in Europe's economic expansion? Instead, are they simply required to pray that the Federal Reserve and the US Treasury will whip up enough domestic demand in the US to suck in European exports, thereby generating the required virtuous circle in Europe itself?

If this is the case - and I have to admit that this is a fairly odd state of affairs - it raises yet more puzzles. European policy makers have been very quick to criticise the US for the creation of global "imbalances" - too much domestic demand leading to excessive budget and balance of payments deficits. Europe may be right to criticise, but it's rather odd to then say that the main driver of economic recovery is exports, when export prospects depend critically on whether the "imbalances" in the US are allowed to build up over time.

Moreover, this approach places Europe in a rather precarious longer-term economic position. If the European economy really is rudderless, sailing strongly one minute, encountering choppy seas the next, it's difficult to see how businesses and consumers can plan ahead with any real confidence.

Last week, IFO (the Institut für Wirtschaftsforschun, or Economic Research Institute) in Munich published its latest survey on the German economy. Until recently, this survey had supported M. Trichet's view that Europe's economy had rocket-propelled qualities. Rising swiftly in the second half of last year, the survey pointed to a stratospheric ascent for the German economy in particular and the European economy more generally (see left-hand chart). Over this period, consumer spending remained very weak, actually falling 0.8 per cent in Germany in the final quarter of 2003, but this did not really matter: after all, consumers were only the third stage of this particularly powerful rocket (right-hand chart).

What happens, though, if the rocket launch doesn't go too smoothly? The IFO survey has started to fall before there's been even a whiff of recovery in consumer spending. So much for the three-stage rocket. Suddenly, the ECB is faced with a difficult situation. Industrial activity appears to be weakening globally, is weakening particularly quickly in Europe, and the blue touch paper for consumer spending hasn't even been found, let alone lit.

The ECB will want to blame the structural rigidities that have, no doubt, played an important part in limiting the underlying growth rate of the eurozone economy in recent years. But if exports are so important in generating recovery, it seems odd that the ECB could choose to stand idly by while the euro appreciated so rapidly in 2002 and 2003. This week, the ECB has a chance to put things right by cutting interest rates. Admittedly, this might be a bit of a volte face in the light of earlier official optimism but Europe's economy now needs all the help it can get. The danger, though, is that Jean-Claude and his friends choose to do nothing: after all, it's their party, and they'll cry if they want to.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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