EURO ZONE

The ECB’s one-size-fits-all mission

Friday 16 May 2008

The naysayers huffed and puffed. But in the first quarter of 2008, the euro zone economy withstood the gale-force prognostications of imminent doom.

 
Lumped together, the economies of the 15 nations that share the euro single currency grew 0.7% in the first three months of the year. That’s twice what many analysts had expected – and well ahead of the anemic GDP growth witnessed of late in the US.
 
The main driver was the German juggernaut, with growth of 1.5%. Germany’s 80 million citizens do the yeoman’s work of Europe’s manufacturing and exporting.
 
Of course, as many acknowledge, this quarter’s gains could morph into next quarter’s losses as Europe absorbs the full impact of a strong euro and high food and energy costs.
 
But still, some suggest that the latest stats may be seen as vindication of the European Central Bank’s tactic of keeping its interest rates on hold (at 4%), even as the Federal Reserve has been hard at work serially slashing its own borrowing costs (to 2%).
 
Critics suggest that the ECB’s steady-as-she-goes rate policy favors strong euro zone economies (read, Germany), at the expense of weaker (or weakening) ones such as Spain, Italy, the Netherlands and Portugal.
 
Which in turn begs the question: can a "one-size-fits-all" interest rate ever be fair in an area as diverse as the euro zone?
 
The easy answer is: “No.”
 
But such a query misses the point of the ECB. It was conceived as an ambitious project, one aimed at creating greater European prosperity by harmonizing policy on a macroeconomic level.
 
That’s why any aspiring euro zone entrant must meet basic criteria on inflation, debt and public deficits.
 
A tall order, you might say. And you’d be right. Charles De Gaulle famously spoke of the difficulty of uniting a country (France) with some 350 different cheeses. The euro zone doesn't have 350 economies - but 15. Yet at times the ECB chief, Jean-Claude Trichet, must feel like the headmaster of a very unruly class.
 
That’s because Europe’s central bank is bound to disappoint some of its members, some of the time. And these days, its basic mission has even been called into question by politicians such as France’s president, Nicolas Sarkozy, who regard many of the ECB’s policies as a hindrance to their own economic agendas.
 
Such attitudes clash with the ECB’s mission to remain independent, above the fray of narrow political interests – a mission enshrined in its founding principles.
 
Some of the resentment of the ECB may also be rooted in its history.
 
At its inception, the bank was modeled on Germany's Central Bank - the Bundesbank. Before the euro single currency was even a figment of any policymaker’s imagination, the Bundesbank effectively set the tone for monetary policy across Europe. This was seen as a natural role, given Germany's status (then and now) as an engine economy.
 
Even countries beyond Europe often tied their economic fortunes to those of Germany. One of them was the Baltic State of Estonia. (When I worked there in the early 1990s, its currency, the krona, was pegged to the German mark. It was seen as a monetary insurance policy.) The fact that the ECB is based in Frankfurt doesn’t help to dampen this perception of Germany as a sort of teacher’s pet.
 
In the US, one Central Bank, the Federal Reserve, sets rates for 50 states with often widely varying economic situations.
 
For an institution like the ECB to work effectively, what is perhaps needed are politicians who are able to rise above demagoguery and populism and give the bank the benefit of the monetary doubt, especially in difficult times.