CAMBRIDGE: Europe is on an upswing in growth and euphoria. But how long can this last? Showing the nervousness to be expected of a new recruit, the European Central Bank (ECB) has already fired a premature shot at the still hidden figure of inflation. Will it wait for inflation to really show before firing another volley? Or will the ECB empty its guns at the first rumblings of a stronger business cycle, fearful of accusations of running from battle or of being caught of guard.

The ECB might surprise everyone by a successful policy of pragmatism, in the manner of the Alan Greenspan led US Federal Reserve Board. The ECB, however, should not expect to be popular in the way Mr Greenspan is. It should simply try to be successful. At this stage, success for the ECB means one thing only: inflation below 2%. Everything else, including lack of a persistent economic upswing can and should be blamed on Europe's supply side.

Within a year of its establishment the ECB found its way to safe ground: it accepted the advice of Hans Tietmeyer, former head of the Bundesbank, concerning the proper "cruising speed" for Europe's economy. To keep inflation below 2%, cruising speed cannot exceed 1.5%. That leaves just enough room for accidents that add to inflation to happen and yet stay below 2%.

Today's upswing is the test. Coming from a point where inflation is barely over 1%, Europe's upturn will inevitably add to inflation. The risk of passing to 1.7% in the year ahead motivated the ECB's recent 50 basis point hike. In capital markets, the commitment to fight inflation, to not be even remotely experimental, was welcomed with a lower long-term rate.

Over the next 6 months we will see how wage rounds are conducted in the new Europe. To paint the extremes, there are two possibilities. First, and most optimistically, wage earners throughout the new EMU zone understand the force of permanently fixed exchange rates. With trade open and unrestricted, with exchange rates gone, labor in each country has lost much, if not all, of its pricing power. No union can still pretend that it has captive employers who can and will pass wage increases on into prices without reckoning the consequences for profitability and employment. In this vision of a New European Economy, wage discipline will be stunning. So, the ECB will encounter no problem of inflation being driven ahead by wages. Growth can go forward at a significant speed, for wage inflation is no longer an issue.

The pessimistic argument is this: nothing has changed; Germany and France had fixed rates for years; so too Austria, the Netherlands, and Spain. The only that has changed is that governments are now leftwingish almost everywhere, most dramatically in Germany. In this view, labor views business as mostly captive, markets as segmented, and the unemployed as generously supported by the State. So, no more wage moderation; with profits back it is time to get higher wages for workers back, too.

We won't know for a few months which alternative will prevail. But it helps to look ahead and appreciate the narrow room for maneuver facing the ECB. With inflation near Tietmeyer's cruising speed, there are only a few tenths of a percent of extra inflation that can be accepted, maybe 1.7 rather than only 1.5%. Indeed, we can already hear the ECB's refrain: Assuredly, nobody will argue that a an extra one-tenth percent of inflation helps growth; surely everyone must agree that an unambiguous success on keeping inflation below 2% does help growth. Thus, no experiments. The ECB will then raise interest rates to slow European growth. If the EU or the ECB forecast near 3% growth for two consecutive years, watch for interest rates to jump.

The ECB has arrived at where the Bundesbank was for over a decade. The central bank cannot create growth in an economy that has a bad supply side; in the US, with highly competitive markets, the central bank can afford to stand by. In Europe, where competition and flexibility are in short supply, indeed are disdained by political leaders, the central bank must be preemptive. When in doubt, fire.

The ECB is right to establish its inflation-fighting credentials; it is right to be unambiguous in educating labor markets to its total unwillingness to accommodate the old ways. Only when that point is established, if necessary at the cost of a growth slowdown, can we expect to start seeing improvements in labor market behavior. Even a slowdown will not be enough so long as governments accommodate unwarranted real wage gains (and the resulting unemployment) with generous income support. The payoff for Europe cannot come from the central bank, it must come from governments recognizing that the ECB cannot create growth. Only they can create the conditions for growth by allowing for a far more competitive supply side.

But it is hard to see even the smallest indication of a more competitive supply side. Governments, most strikingly in Germany, seek to escape from their political dilemmas by talking about the transition to a learning society and other dreams. At the same time, however, they go out of their way to stop radical cures through aggressive mergers or tough corporate workouts.

None of this will change without a crisis. But Europe is rich and for that reason won't have a crisis any time soon. In essence, Europe is satisfied with low growth and borrowing from its grandchildren just because that keeps the peace and it keeps confused and undecided governments in power just a bit longer. In fact, not just a bit, they can surely play the same game for another decade.

If Europe's economy performs poorly, blame Schroeder, don't blame the ECB. A new central bank and an old economy mean one thing: low inflation and low growth.