CENTRAL banks are very good at damaging economies but much less so at mending them. Usually, the best thing that monetary policy can achieve is neutrality: to allow the private sector to conduct its business while enjoying monetary stability.
Occasionally, that might require injecting vast amounts of cash into the economy, especially if the money supply would otherwise be collapsing, perhaps because of a bank crisis. A sudden reduction in the amount of money in circulation usually has a catastrophic impact, triggering a recession and putting downwards pressure on prices and wages.
But it is always time to panic when a central bank ceases to see itself as neutral enabler of the private sector – seeking to ensure that the supply and demand for money balance at an interest rate that reflects the underlying economy (in itself an impossibly tough mission) – and instead begins to act as a deus ex machina, an activist that believes it can create perpetual growth by micromanaging and relentlessly intervening.
Some, but not all, of the criticism of the ECB is deserved. Crucially, it is far more aware of its inherent limitations, economic as well as political, than either the Fed or the Bank of England – and many of its critics suffer from a hubristic view of what monetary policy can actually achieve.
The ECB’s greatest failure is that nominal GDP (changes in real GDP, and inflation) in the Eurozone is now barely increasing, confirming that the region faces a real slump.
That said, cutting the ECB’s main rate from 0.75 per cent to 0.5 per cent will make no discernible difference. Such changes are trivial at the best of times – though always damage savers – and have become useless in current conditions. Consumer price inflation was an exceptionally low 1.2 per cent in April; the Eurozone doesn’t suffer from the UK’s problem, which is excessively high inflation. So the cut can easily be justified on the basis that real rates have actually been going up, not down – in fact, the 0.25 per cent rate cut didn’t even cancel out the 0.5 percentage point fall in inflation (and thus rise in real rates) between March and April.
The Eurozone remains in an extraordinarily deep crisis, caused by a multitude of factors, and none of the other measures announced yesterday will make a blind bit of difference. The Bank left the deposit rate at zero; as Capital Economics argues, it feared that a reduction into negative territory could cause banks to increase their own lending rates to maintain profitability. The ECB will continue to provide three-month loans at a fixed rate for another year at least; but given that this has been happening since October 2008, it is a meaningless measure.
The problems facing the Eurozone are exceptionally large. They include mad fiscal policies, with many countries facing excessively large debts; appalling supply-side policies, with far too little competition and far too inflexible wages; excessively high tax rates; bloated governments and welfare states; the euro itself, and its one-size fits all monetary policy which, when combined with the inability of rigid labour markets to adjust, was always going to be a recipe for disaster; a broken banking system, partly as a result of the previous factors; and a region riven by imbalances. There has been some progress in some economies with unit labour costs coming back into line, but France, Italy and Spain are in real trouble, as are Greece and Portugal.
The ECB is partly responsible for the Eurozone’s nightmare but just about every other country and bureaucracy in Europe is equally to blame.
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