Transatlantic Perspectives
The ECB’s Tone-Deaf President
Melvyn Krauss
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PALO ALTO – Once upon a time, European Central Bank President Jean-Claude Trichet communicated effectively with the outside world. Not anymore.
More than a few eyebrows were raised after the ECB’s January Governing Council meeting, when Trichet threatened that the Bank would act “preemptively” if labor unions tried to embed higher energy and food prices into new contracts, risking a wage-price spiral.
This threat took a heavy toll on the ECB’s credibility, since an interest-rate hike in the midst of the most serious financial crisis in decades was obviously absurd. No one believed it, and the ECB not only withdrew its clumsy threat the next month, but it adopted a policy of interest-rate neutrality.
But the announcement of this policy change at the February meeting also did not go smoothly. Trichet somehow garbled the Council’s message in his press conference, making it sound as if the ECB wanted to shift to an easing bias instead of “wait and see” neutrality.
European fixed-income markets rallied strongly as a result, only to reverse course days later when Trichet and his colleagues made it clear that the markets had “misread” him. So there was unwelcome and unneeded market volatility because Trichet couldn’t get the message out straight.
Indications that Trichet’s communicative skills were slipping already had become evident last September, when the Governing Council could not follow through with the rate increase the ECB president had promised the previous month.
For some unknown reason, Trichet is keen not to surprise markets over the very short term. He tips them off about what he plans to do one month in advance, using code words like “vigilance” to signal policy change, all the while maintaining with a straight face that the bank never “pre-commits” its policy stance.
Many on the Governing Council object to this childish game of code words, because it eliminates their freedom of action once the Council commits itself to a course of action. The Council may then be forced to choose between doing the right thing and preserving the credibility of the ECB’s communications.
This is precisely what happened in September, when the financial crisis made it impossible for the ECB to proceed with the interest-rate hike that it had “announced” in August. Code word communications, which only work in a stable and crisis-free economic and financial environment, had damaged ECB credibility.
Calm economic waters had given the ECB and Trichet a honeymoon until last fall. But, with financial markets now in turmoil and likely to stay that way, the time has come for the ECB to jettison its use of code words – a poor substitute for real central bank transparency in any case.
What also needs to be jettisoned from the ECB’s communications policy is its obsession with the short run. With the United States now in recession (and the possibility of a deep recession not that remote), it is striking how positive ECB officials sound about the European economy: Europe’s “economic fundamentals are sound,” the economy is “robust,” economic performance is “just below potential,” and so on.
The ECB’s policymakers are not blind, merely shortsighted. They fear that honesty about Europe’s economic prospects over the next year or so might cause markets to force it into an unwanted rate cut now. So they exaggerate and tell stories about how the European economy is fundamentally different from the US economy.
This is a major mistake, for which the ECB could pay dearly. Yes, today the European economy is not doing badly. But how long is this likely to last with the US falling into a deep slump?
The ECB should be preparing Europeans for what many of its own officials admit in private: Europe has not “de-coupled” from the US. On the contrary, America’s current economic difficulties will hit Europe hard, but with a time lag – the best guess being 2009.
This is not to argue, of course, that the ECB should cut interest rates now. On the contrary, the Bank’s current policy of fighting inflationary pressures by slower growth, a stronger euro, and the credit crunch seems just about right for the time being.
But, after all the happy talk about the European economy, how much credibility will the ECB have if Europe eventually succumbs to recessionary pressures from abroad? The ECB’s independence is still a contentious political issue in Europe. It is more prudent that it voice concern for Europe’s future economic prospects today than face a deceived and angry public tomorrow.
Melvyn Krauss is a senior fellow at the Hoover Institution, Stanford University.
Copyright: Project Syndicate, 2008.
www.project-syndicate.org
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