Out of Step at the ECB

In the midst of the most serious financial crisis in recent memory, the ECB refuses to cut interest rates, and even continues to insist that it might raise them. That is an unconvincing bluff, but one that reflects the predicament in which the ECB finds itself after leaving interest rates too low for too long.

The European Central Bank remains seriously out of step with other key central banks in the industrial world despite recently announced coordinated efforts to increase short-term liquidity in the banking system. The United States, Canada, and the United Kingdom all have cut interest rates recently. But the ECB holds firm against cutting; indeed, after the Governing Council’s December meeting, ECB President Jean-Claude Trichet said that some members were in favor of raising rates.

Who are they kidding? Everyone knows that the ECB cannot raise interest rates now, and for some time to come. In the midst of the most serious financial crisis in recent memory, the ECB has resorted to an unconvincing bluff, because it has an inflationary expectations problem.

Past policy missteps are responsible for the ECB’s present predicament.

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