Outlook: Euro weakness
Wednesday 03 March 1999
This is becoming an ever more silly and damaging game of who blinks first. We cannot be seen to do what the politicians tell us, the ECB seems to say, as that would damage our credibility. So we can't cut rates, even if we thought there might be a case for it. So silly has the process become that Mr Flassbeck might be more likely to achieve his desired aim if he were to demand a rate increase than by speaking his mind.
Meanwhile, the euro seems to have been born a sickly infant. As yet it is unclear whether this is more to do with the weakness of the German and French economies than the likely counter cyclical direction of European and American interest rates. The ECB claims to have no exchange rate target, or indeed to take the exchange rate into account at all in making its interest rate decisions. But plainly currency weakness has become as good an excuse as any for not cutting rates.
Politicians are a devious lot, and there is certainly a degree of "blame management" in whatever Mr Lafontaine has to say about the ECB. By blaming the ECB, he can to some extent deflect attention from his own policy mistakes. By the same token, it makes good sense politically to make the ECB a scapegoat for the euro's wider problems. If the euro is a disaster, it won't be the politicians who invented it who are to blame, but the ECB. Even so, it can reasonably be assumed that Mssrs Lafontaine and Flassbeck do genuinely want interest rate cuts.
So how can the ECB be persuaded to do its duty? One possibility is that politicians have chose too simplistic a target. A big problem with the ECB as presently constituted is that it has no proper inflation target. The main instrument for determining policy is monetary targeting, commensurate with the general target of keeping inflation below 2 per cent. There is little guidance as to what this means, though it is generally assumed the ECB wouldn't pursue price deflation as a policy objective. Even so, the assumed range of 0 to 2 per cent creates a ready zone of inactivity, and potential for exactly the sort of paralysis the ECB now seems to be suffering from.
By contrast, the Bank of England's inflation target is a symmetrical one. It is as much of an offense to overshoot on the downside as on the upside. This seems such an eminently sensible approach to reconciling the policy aim of full employment with that of low inflation that it is amazing our European part
ners haven't yet seen fit to copy it.
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