Understanding eurozone monetary policy ?
As the ECB chose to raise rates last week for the third consecutive time we are bound to ask whether it was prudent or not. For me the answer of this question is not important in itself but more so it is important to ask why we are questioning the ECB's decision and crucially why both camps' arguments are worth pondering.
Take for example the ECB's rationale for raising rates as it is so excellently summarized in the latest post by Nouriel Rubini.
1. Inflation is above the ECB's 2% threshold.
2. Latest indicators signal a recovery in the eurozone.
3. The rising house/asset bubble in the eurozone is something which the ECB wishes to contain.
This, I guess is all well and good!
(from the FT)
"Many economists and the OECD are sceptical about the need for further rates rises, although recent improvements in eurozone business and consumer sentiment have muted criticism of the latest ECB rate increases."
For me this epitomizes the conundrum of monetary policy in the eurozone. If the ECB tries (as seems the case now) to be vigilant against inflation by prickling asset bubbles through tightening it risks thwarting the recovery and growth which are by no means given at this stage. But then the ECB migth lose its "vigilant against inflation" profile.
What is the right policy here then? Personally I am with Rubini when he says ...
"Thus, my suggestion to the ECB: take it slowly and easy. Since core inflation is falling and there is no Eurozone-wide housing bubble, you can sit back until you have stronger signals of a strong and resilient Eurozone-wide growth recovery before you tighten too much. The cost of waiting a little longer are limited but the risks of doing too much too early are larger. So, if growth is recovering, Trichet and his fellow governors may want to sit back and enjoy it for a little while; after four years (2002-2005) of dismal growth in the Eurozone area, a little growth above 2% with little signs of core inflation should not hurt anyone."
But by god would I be struggling if I were in Trichet's shoes.