The anti-inflation obsession of the ECB brought under the limelight by the American monetarists
The recession cycle towards which Europe tends seems to have been triggered by the rate decisions taken by the ECB in the spring and summer of this year. Why is there such European blindness to the risks to growth brought forth by those decisions while in the US, those professing the same monetarist ideology, start to give equal weight to the fight against inflation and to upholding demand and thus employment?
During the month of April 2011, the European Central Bank, through the bias of its president Jean-Claude Trichet, raised the target rate by 25 basis points. That rate hike, small as it was, sent a clear message to the markets: monetary policy will not tolerate an increase in inflation and feels it is obliged to constrain aggregate demand. It cannot be attributed to chance the fact that that message dated April 2011 correlates perfectly with the increase in unemployment and the contraction of economic activity.
The rate decisions by the ECB were without doubt the starting point of the recession.
The double rate hike decisions of April 7th and July 7th, through the bias towards further rate hikes they imparted , thus decreasing aggregate demand, was the starting point for the reduction in the forecasts for growth and inflation and for the increase in the unemployment rate forecast in France and in Europe.
Those decisions also renewed uncertainty over the levels of public debt since lower growth forecasts would worsen the national accounts. The fear engendered by the orthodoxy of monetary policy had considerable influence over the marked deceleration in economic activity beginning last summer.
Aggregate demand – which is the sum of all demands for goods and services in an economy – is traditionally the focus of monetary policy. The ongoing talk giving rein to fears of inflation as justification to all the actions taken by the ECB conveniently forgets that monetary policy directly influences aggregate demand and not the inflation rate. We tend to forget that step. In this context, the ECB´s decision in April sounded like an advertisement: the feeble demand would weaken further.
The increase in unemployment after April is certainly not surprising; it was deliberate. The mistakes, identical to those committed in 2008, did not teach anything about the effects of a monetary policy geared to price stability. It has become blatantly clear at present that mastering inflation is no more the way to generate an environment amicable to economic development. The ECB under Jean-Claude Trichet has turned price stability into an end in itself, completely oblivious to the ultimate goal of all economic policy: growth.
The ECB is not responsible for the debt levels of States, but the signal sent out to the markets was akin to throwing a lit match on hay. At the end of his tenure, Jean-Claude Trichet congratulated himself on his accomplishments, saying he had done even better than the Bundesbank in its time, having kept inflation below 2%. The fact that unemployment in Europe is above 10% is of secondary importance.
Mario Draghi´s intervention of December 8th takes a similar route, notwithstanding the double rate decrease since his arrival. The Bundesbank doctrine remains the backbone of European monetary thought, in spite of present evidence of its utter failure.
In the US, in contrast to the ECB, the monetarists have given up taking the fight against inflation as the sole objective of economic policy.
It should be noted that at present the debate introduced by the “market monetarists” is very vibrant in the US over the very nature of the Central Bank´s mandate. The number of supporters for a policy based on demand, more precisely nominal GDP (i.e. including inflation), is visibly increasing.
It is not about putting in place an inflationary policy, but rather a policy that takes into consideration, with equal weight, both price stability and the level of demand, and thus employment. The remarkable job done by Scott Sumner, economics professor at Bentley University, on Nominal GDP Targeting is gaining considerable traction in the US. The subject is now being discussed within the Federal Reserve, following the appearance of articles on the topic by Christina Romer, former Head of President Obama Counsel of Economic Advisors, in the Op-Ed page of the New York Times; Paul Krugman, Nobel Prize recipient, in his New York Times blog and Jan Hatzius, Chief-Economist at Goldman Sachs. Such major academic contributions to an understanding of the monetary nature of the crisis is still absent from the European debate.