The European Central Bank, which directs monetary policy in the 12 countries that share the euro, cut interest rates Thursday by 50 basis points, or half of 1 percent, to 2.75 percent despite the fact that monetary growth and inflation are both above the ECB's own targets.
But with its benchmark interest rate still more than double the 1.25 percent rate set by the U.S. Federal Reserve, the Europeans are still playing a far more cautious game than that of Fed Chairman Alan Greenspan.
The comments of ECB President Wim Duisenberg at Thursday's press conference in Frankfurt, Germany, were revealing. They might be interpreted either as grounds to ridicule the ECB's caution or to applaud the fact that it wants to retain some statistical guidelines for its policy-making.
Duisenberg said the ECB will continue to use as one pillar of its decision-making the annual pace of M3 monetary growth -- a broad measure of the money supply. The ECB's upper limit for M3 growth is 4.5 percent. Yet the ECB cut rates substantially Thursday with M3 growing, as Duisenberg acknowledged, at an annualized rate in August to October of 7.1 percent -- some way above the ECB benchmark.
The other pillar of policy-making is the average inflation rate in the euro-zone. The ECB's medium-term target -- so that short-term aberrations caused say by very high energy price rises may be partly disregarded -- is a rate of 2.0 percent. Despite the fact that the European economy grew by no more than 0.3 percent in the third quarter -- equivalent to annualized growth of 1.2 percent; far behind the 4 percent annualized growth achieved in the United States in the third quarter -- eurozone inflation in November is preliminarily estimated to be 2.2 percent; just like money growth, above the ECB's own guideline.
Duisenberg argued however that M3 growth has been "influenced considerably by portfolio re-allocations in an environment of general uncertainty and particularly by stress in financial markets."
The implication was that this phenomenon was temporary. And as for inflation, he said, "Both the overall economic environment and the euro exchange rate, which has strengthened since early this year, will contribute further towards reducing inflationary pressure." Thus, the small breach of the ECB's 2 percent inflation guideline could be ignored, Duisenberg implied.
Economists are welcoming the rate cut. Robert Prior, European economist at HSBC bank in London, said, "It's official, the ECB does care about growth after all." But he expects European growth "to continue to disappoint over the coming months and we still look for a rate trough of 2.25 percent. At this stage, we would expect the next cut in April."
Simon Tilford, a London-based economist and consultant, said "The move is clearly positive and should go some way to arresting the decline in consumer and business confidence in the euro-area."
But Tilford pointed out that the cut "still leaves real interest rates very high in Germany. German inflation fell to 1.1 percent in November and very low or even negative real interest rates would arguably be appropriate in Germany at present."
So Wednesday's rate cut is not enough, and most economists would continue to judge Duisenberg's caution excessive. In a weak economy an uptick in inflation is hardly likely.
Yet the ECB's cautious approach perhaps deserves to be considered on its own merits. It is an approach fundamentally different to that of Greenspan and the U.S. Federal Reserve.
Duisenberg plays down the monetary policy role in promoting growth. "There is ample liquidity in the euro area," he said Wednesday. "Geopolitical tensions with potential consequences for oil prices, developments in financial markets, the sluggish growth of the world economy and the persistence of global imbalances are all factors that weigh adversely on confidence," he said. His implication was that a possible war with Iraq, falling stock markets and "global imbalances," probably a reference more than anything to the big U.S. trade deficit, are neither his fault nor something that he should necessarily react to. For abandoning policy guidelines and making monetary policy accommodative in the face of every shock could itself lead to problems.
And perhaps has done. The U.S. stock market bubble -- which might be judged now a big part of the world economy's problems -- blew up to its fullest and most extreme extent in 1999 after monetary policy in the United States had reacted to a default on debt by Russia and crisis in Brazil and the failure of a big hedge fund, Long Term Capital Management, based in Greenwich, Conn., all in the second half of 1998. Was policy too accommodative then? Are we paying the price now?
The circumstances today may fairly be considered very different. Generalized economic weakness and weak stock markets are the problems. If Duisenberg were to cut rates more rapidly, he is unlikely to find himself being accused subsequently of fomenting a stock bubble. Neither growth nor stock markets are about to soar.
But, then again, accommodative monetary policies in the United States are sending house prices into the stratosphere. Perhaps that is not a place cautious Duisenberg would want them to be. Duisenberg points out that interest rates in Europe are at "a very low level by historical standards." His assertion that monetary policy cannot solve all growth problems may be a wise one. It may have been a loose, accommodative monetary policy, not a tight one, that has submerged the world economy in perplexing, hard-to-counter weakness.
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