Interesting interpretation of Trichet’s comments regarding ECB policy
Eurointelligence cites a Die Zeit interview (the original interview here) with ECB central bank President Jean-Claude Trichet. Their take on it is quite interesting, which suggests that most are ‘wrong’ about the path of ECB policy. According to Eurointelligence:
Central bankers are trained not to say anything of any relevance in long speeches or interviews, and Jean-Claude Trichet is a master at this. So we were a little surprised when he told Die Zeit that governments should fine tune their fiscal policy in the fight against inflation. Here is the quote: “Individual countries must accept the monetary policy as a given and adjust their national policies accordingly…When a country experiences a boom, it needs to make its own national policies …more restrictive in order to avoid the economy overheating or speculation getting out of control.” The policy consensus has been for the last few decades that monetary policy is the instrument of choice to control inflation and inflation expectation, while fiscal policy should be oriented towards medium-term goals. Fiscal policy has a role to play in countries that overheat relative to the rest of the eurozone – like Spain before the crisis – but this is hardly applicable now. (If you consider Germany as overheating, there is not much you can do with fiscal policy to constrain the inflationary pressures, especially considering the time lags through which fiscal policy operates. We interpret Trichet’s statement as saying: monetary policy is currently constrained, so fiscal policy is all we have got. This is quite extraordinary, and makes us wonder whether the ECB is really determined to prevent an upward drift in inflation.)
(read on after the jump!)
RW: This could be a very astute representation of Trichet’s comments: that fiscal policy should be the main tool to target inflation expectations to the upside if the ECB feels they are taking care of the downside! The implication is that the ECB is ‘on hold’ for much longer than markets expect. Today, for example, the Eonia forward swap curve (the Eonia rate is the Euopean equivalent of the federal funds interbank rate) has 25 bps in ECB rate hikes priced in through August 2011, 50 bps through the December. The Eurointelligence interpretation of Trichet’s comments would suggest that this is way off, that the ECB is on hold for some time.
There are several caveats to consider regarding the ECB’s policy stance:
(1) As I’ve argued before, German wage pressures are bound to get a bit frothy this year, which may challenge the ECB’s resolve. If those pressures are more robust than history demonstrates – I argue that they will – a new ECB president would be less accommodative in its policy response than Trichet implies…
(2) …which brings me to my next caveat: Trichet’s term as ECB President ends in October 2011. His successor – the most likely candidate at this time is Mario Draghi – will then take the monetary policy scepter. Will he/she hit the ground running? Better put: will he/she hike rates right out of the gate if German inflation and/or commodity price inflation is perking up?
(3) The ECB has been known to jump the gun with regards to commodity prices. Trichet, in his February policy statement, reiterated that he expects near-term price inflation to see its fair share of time above 2%; this suggests that he may have learned his lesson in 2008 (see this post regarding the ECB’s reactionary policy).
Fun stuff!
Rebecca Wilder
Rebecca,
You wrote:
“This could be a very astute representation of Trichet’s comments: that fiscal policy should be the main tool to target inflation expectations to the upside if the ECB feels they are taking care of the downside!”
The good news is this explains why the ECB is doing absolutely nothing while the entire Eurozone Stag-deflates.
The bad news is that countries like Greece (which just suffered its 10th negative quarter of real GDP growth in a row) are between a rock and a hard place. Either they try and stimulate their economies by expanding their deficit and go insolvent or they allow their GDP to implode dragging down government revenues and still go insolvent. (Not much choice is there?)
This is pure insanity and it will end up as a disaster for the entire Eurozone (including Germany) unless something dramatically changes. Draghi has blown off some reassuring tight money smoke signals to placate the Germans in his drive for the ECB presidency. I hope that it is in fact all smoke and mirrors and that he turns out to be a Trojan Horse instead.
@ Mark “This is pure insanity and it will end up as a disaster for the entire Eurozone (including Germany) unless something dramatically changes.”
I agree – but the the insanity is the fiscal austerity. The ECB’s just playing its part in the game of bad policy in Europe. Ireland’s been in deflation since early 2009 on a harnominzed basis – and that’s what you get when the government is trying to push its financial balance upward while the private sector financial balance (excess saving) remains starkly elevated. Spain and Greece will follow as soon as the VAT hikes dissipate to reveal the true inflation bias.
Without heroic current account surpluses (I mean epic, really), the deflationary hole that is aggregate demand relative to supply will eventually drive up fiscal deficits as tax receipts fall flat. My point is, that fiscal austerity won’t work, and the impetus to prices is going to be down, not up. The only hope for the Periphery is that Germany runs huge current account deficits (exporting capital to other countries) – and signs of that objective being accommodated by either monetary or fiscal policy makers is NEIN!
Rebecca
Rebecca,
I truly believe fiscal policy in this environment is a doom if you and a do and doomed if you don’t type thing. Unless the fiscal multiplier is really remarkable all the countries on the periphery will continue to run huge fiscal deficits with or without austerity barring something else to further stimulate AD. Since they are all part of the same currency zone counting on Germany to provide stimulus through trade won’t work barring some rapid readjustments in relative unit labor costs which is largely outside of policy makers’ control. The only realistic way out of this predicament is monetary policy which works when it is truly tried.
Trichet is a talented man but a monetary policy amateur (and an inflation hawk to boot). I have much more confidence in Draghi.
@ Mark: They’re damned if they do, damned if they don’t because they (Peripheries) have issued debt in currency over which the Peripheries have no control. Certainly, a short-term boon to the liquidity crisis (currently ever-present) is the ECB printing unsterilized money…
The eurozone current account deficit is starting to widen as energy and other commodity prices rise. “Expansionary fiscal contractions” are difficult enough to pull off without the current account also draining incomes away from the private domestic sector.
It will take very strong reinvestment of corporate profits for the eurozone to avoid a double dip now, regardless of whether the ECB determines it needs to tighten against accelerating inflation. Last I looked eurozone new orders growth was downshifting (despite favorable business and investment surveys) so this now becomes a trickier juncture for all involved in fiscal consolidation. Maybe that is part of why Axel Weber took himself out of the running for the ECB.