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European
Economic Perspectives 23
So
Far, So Good…
An
Update to Monitoring the European Central Bank (MECB)
Since the launch of
the euro in January, the ECB’s policies have proved remarkably
pragmatic and the Bank has served as an important force for stability in
Europe, the latest MECB Update concludes. In particular, the ECB
responded sensibly, both to the upturn in unemployment in the large EU
economies and to the decline in the value of the euro – in the first
case by cutting interest rates and in the second by doing nothing.
Average inflation in
Euroland countries fell from 1.6% in 1997 to 1.1% in 1998, largely
because of lower energy prices. Real GDP growth increased from 2.5% in
1997 to 3.0% in 1998. This was little cause for optimism, however, given
the size of the adverse global shock in 1998. The coordinated reduction
of interest rates in December 1998 was, therefore, a shrewd move. It
signalled the de facto existence of monetary union ahead of its de jure
start-up. More importantly, it dispelled fears that the ESCB might be
unable to respond to worsening macroeconomic conditions.
Early statements by
President Duisenberg and other Council members indicated that the ECB
wanted to avoid interest rate activism. For three months, the ECB
maintained the interest rate at 3% despite increasing evidence that the
slowdown was indeed materializing – particularly in Germany and Italy,
which together constitute half of Euroland’s GDP. From the outset,
however, there have been asymmetries: GDP has been growing strongly in
Spain and Portugal and especially in Ireland.
On 8 April 1999, the
ECB cut the interest rate to 2.5%, a further step in an already long
period of decline. Nominal interest rates are now at their lowest point
this decade and real interest rates are not high in historical
perspective. But the April decision to cut interest rates was not
uncontroversial. The move thus provides an early signal about the
ECB’s preferences. Three lessons can be drawn, according to the MECB
authors:
• First, while the
ECB had repeatedly stated that it cannot do much to deal with
unemployment, it clearly responded to the risk of a cyclical increase in
some countries. It thus demonstrated that in the absence of any
inflationary pressure, it can support counter-cyclical policies rather
than hide behind its frequently stated goal of medium-term price
stability.
• Second, the
decision was taken at a time when the euro was declining against the
dollar. The ECB thus indicated that it is prepared to treat the exchange
rate with benign neglect. Greater benign neglect of the external
exchange rate may, of course, be a perfectly appropriate response to
monetary union since Euroland is much less open to external trade than
were its individual members. Yet discussions of ECB policy within
Euroland countries are still dominated by the small open-economy
perspective, which is, the MECB Update stresses, now clearly
inappropriate. In any case, it was not the euro that declined but the
dollar that was strengthening, owing to the continuing remarkable
performance of the US economy. So the ECB should not be criticized for
apparently neglecting the decline of the external value of the euro.
• Third, although
the ECB has vowed not to look at national situations, the interest rate
cut is easier to understand in light of the economic situation in the
weaker member countries rather than in light of the aggregate data in
Euroland.
These three messages
show that the monetary strategy of the ECB is evolving, maturing and
gradually stepping out of the shadow of the Bundesbank. The ECB could
have opted for a narrower interpretation of its mandate, repeating the
argument that growth and unemployment are the concerns of national
authorities. That would have been the easy way. By eschewing this
approach, the ECB has demonstrated that it will follow a more balanced
approach.
The ECB has worked
hard to resolve the early problems of being central banker to Euroland.
As emphasized in the inaugural MECB report published in the autumn of
1998, time was not on its side, global conditions were less favourable
than might have been the case, and reconciling disparate interests and
traditions is never easy. The ECB should be congratulated both for
avoiding some of the dogmatic positions into which it might easily have
fallen, and for its continuing openness to ideas and discussion.
The first MECB Report,
published in October 1998, identified many challenges for the ECB. The
Update does not discuss them all in detail, but argues that it is useful
to keep score and take stock. At the time of the issue of the ECB’s
first Annual Report in April 1999, the MECB team’s assessment can be
summarized as follows:
Problems resolved:
• Price stability
defined
• Benign neglect of exchange rates largely established
•
Monetary policy already dedicated to wider objectives
than mere pursuit of price stability
•
Importance of banking supervision recognized
• European mode of thinking within the Council established
• Early credibility with financial markets
• Adequate reporting of Euro-aggregate numbers
• Establishment of a smoothly working payments system
Challenges remaining:
• Transparency still
inadequate
• Monetary policy strategy still too vague
• Monetary actions need to match the declared strategy
• Inflation forecasts and their relevance need to be clearly discussed
• Differences across regions and their relevance need to be assessed
• Centralization of authority within ESCB needs to progress further
• Further coordination with supervisory bodies is desirable
• The linkages between the various payments systems need to work more
smoothly
The full
text of MECB Update is available from CEPR. The first full
report was published by CEPR in October 1998: ‘The
ECB: Safe at Any Speed? Monitoring the European Central Bank No.1’
by David Begg, Paul De Grauwe, Francesco Giavazzi, Harald Uhlig and
Charles Wyplosz.
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