29 March 2012

Stewart Fleming: There's no such thing as easy money

Now is the time that Germany's central bank, the Bundesbank, would like to start raising its interest rates. But in the eurozone, which, taken as a whole, is in a mild recession, the levers of monetary policy are in the hands of the European Central Bank (ECB), and it no longer marches to the Bundesbank's tune.

Germany has, intermittently, been defeated in the ECB's governing council, a forum in which even the smallest of the 17 states of the eurozone has a vote equal to that of Germany. The intellectual hegemony over monetary policy that the Bundesbank enjoyed as the main architect of the ECB's monetary policy strategy no longer holds sway.

Slow growth and the sovereign-debt crisis mean that the priority of many eurozone countries is to focus on the short term, keep interest rates abnormally low and, if necessary, tolerate a bit more inflation.

So the staunchly anti-inflationary, medium-term monetary-policy strategy that the ECB inherited from the Bundesbank is out of favour, even though today's easy-money policies are storing up trouble for the future. It is only the Bundesbank that is stressing the daunting challenge of escaping from the monetary narcotic to which the ECB, in desperation, has had to resort, injecting into Europe's troubled banks €1 trillion of cheap three-year loans.

The current situation is doubly ironic. Germany has just seen its strategy for coping with Europe's sovereign-debt crisis begin to bear fruit. The new EU/eurozone economic-governance regime is far from perfect. But, combined with the disciplines that financial markets will now impose, it amounts to a step change in rigour. 

Progress on this front for Germany, and allies such as the Netherlands, has, however, been offset by what they fear is a loss of influence at the ECB. This, they fret, may mean the single ‘hard currency' that they created over a decade ago is becoming a ‘soft currency' like the dollar and sterling, prone to the twin evils of inflation and devaluation. 

The second irony is that in its early years the one-size-fits-all single interest rate for the entire eurozone was too low for countries such as Spain, Ireland and Greece, but just what the economic doctors ordered for Germany. Today, rock-bottom interest rates are too low for Germany. 

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