Mexican Lessons for Eastern Europe

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%.