The ECB’s Bridge Too Far

BERKELEY – Is Europe’s economic crisis mutating once again? If debt fears are now being superseded by the danger of deflation, as recent data suggest, the European Central Bank has its work cut out for it – and there is nothing to suggest that it is up to the task.

The numbers are alarming. Core inflation (the consumer price index after excluding volatile food and energy prices) in the eurozone fell to an annual rate of 0.8% in October – a 47-month low – while producer prices fell by 0.5%, suggesting that deflation is already in Europe’s economic pipeline. Annual growth of M3 money supply, meanwhile, dropped to 1.4% in October, from an already dismal 2% in September, while loans to the private sector contracted by 2.9% year on year. All of this makes it remarkable that the best the ECB could do at its December meeting was stand pat.

So what should a good central bank be doing? For starters, it should focus on maintaining appropriate monetary conditions and get out of the business of negotiating policy conditionality with governments. A central bank’s core mandate is to keep inflation at appropriate levels, not to negotiate structural reforms with countries like Greece, a task that is best left to the European Commission and the International Monetary Fund.

Similarly, the ECB’s outright monetary transactions (OMT) program, announced in the wake of President Mario Draghi’s “do whatever it takes” speech in the summer of 2012, is at best a distraction. While a central bank should ensure the smooth operation of the payments and financial system, it makes no sense for this task to be contingent on governments’ negotiation of a reform program with the European Union’s rescue fund, the European Stability Mechanism (ESM), as is the case with OMT.