The story behind the intrigue at the ECB

Today’s commentary

According to an account in the Financial Times last week, the latest rate cut by the ECB created a worrying north-south split, with the German-centered group opposing rate cuts and the southern faction wanting them. Today Austrian and German central bankers went to the press to counter this portrayal and affirm their desire to keep ECB monetary loose. Below I have some thoughts on the issue. 

The original FT article by Peter Spiegel and Stefan Wagstyl was headlined “ECB split stokes German backlash fears”. It told of a north-south divide, adding that “among those who voted with the two Germans on Thursday were the heads of the Dutch and Austrian central banks.” Along with the full court press Hans-Werner Sin was making in the German press against the ECB’s low rate policy, it seemed that there was indeed a significant split.

But today the story seems slightly different. Three Austrian papers I read and one German news source all reported that the divide hinted at in the FT doesn’t exist. In fact, German ECB member Jórg Asmussen went as far as to hint that more easing was in the pipeline, something that caused the euro to fall. Below are my translations of the relevant parts of these articles.

• Kurier (Austria): “There is no north-south divide in the Governing Council ,” said National Bank Governor Ewald Nowotny on Tuesday , responding to a report by the ‘Financial Times’ (FT ), according to which he was one of the “rebels” who voted against the latest key interest rate cut by the ECB . “This is misleading,” Nowotny said. There haven’t been differences on whether the rate cut should be given, only about the timing, the central banker said in a meeting of Pioneer Investments in Vienna. “The drama which was depicted there is not realistic,” Nowotny said… The rate cut itself was not really surprising, according to Nowotny, because the ECB has a very clear mandate for price stability. This is defined by the ECB as not allowing inflation to exceed 2 percent , but to be close to 2 percent. You must therefore fight not only against inflation but also against deflation, and that is the real problem. After all, inflation was very low in the euro area in October at 0.7 percent. “The Austrians and the Germans are people who like to be afraid of something,” Nowotny said. “But you have to fear the right thing, and that is not the risk of inflation. Stagnation is the real danger.”
• NTV (Germany): Speculation about an early tightening of U.S. monetary policy has made the U.S. currency buoyant. The Euro fell in the morning to an intraday low of $1.3357 from $1.3406 at the end of business the day before… “The recent better than expected U.S. employment data will help the dollar ,” said Niels Christensen, currency strategist at Nordea… The dollar is also getting a boost, according to Christensen, from the prospect of continued loose monetary policy in the euro zone. Since the surprise ECB rate cut last Thursday, the euro has been sent reeling. ECB Director Jörg Asmussen told the “Neue Osnabrücker Zeitung,” that even after the latest rate cut, the central bank has not yet arrived at the end of its options, depending on how inflation develops.

So Nowotny is saying that all of the ECB Governing Council members believe that deflation is the greater threat in the eurozone. And Asmussen takes him one step further saying that more policy accommodation is coming, depending on how inflation develops. In my view the statements by these central bankers make clear that there is no north-south divide at the ECB. Rather, there are differing views about just how aggressive the ECB needs to be to prevent deflation from becoming a problem.

The ECB’s role is complicated by a number of factors, the most significant of which is the lack of economic convergence in Euroland. A one-size-fits-all monetary policy is always going to have difficulty being effective under those circumstances. For example, Handelsblatt pointed out yesterday that German life insurers have many contracts from the 1990s that guarantee rates of return of 4% to households. That’s a problem when the ECB’s rate is 0.25%. German life insurance is a vehicle many German households use for saving. Think of this German insurance problem as a much smaller scale version of the S&L problem from the 1970s, with its asset-liability return mismatch that led first to regulatory forbearance, then a reach for yield into junk bonds and then to the S&L crisis. 

This is why the German-language press is in an uproar over the cut despite the acknowledgement at a policy level that a cut was necessary given the macro outlook in the eurozone.

Jeremy Warner at the Telegraph makes some good points on this score. He says “Don’t blame Germany for the eurozone’s travails, blame the euro itself.”

In any case, to blame Germans for standing in the way of a resurgent Europe is just a little too convenient. It also misdiagnoses the nature of Europe’s problem. It’s not Germany, still less its economic success – if indeed you count expected growth this year of just 0.5pc as success – which is at the root of the difficulty; it’s the euro.

I’ve found it impossible to ascertain who was originally responsible for the expression “one size fits all monetary policy”; Eddie George, former governor of the Bank of England, used it in the context of the single currency as far back as the late 1990s, though it possibly has a much longer pedigree.

Yet the problem it defines is the same today as it has always been; any attempt to set a single interest rate for 17 politically and fiscally sovereign nations is almost by definition doomed to failure. Perpetual crisis is more or less guaranteed.

It is hard enough setting monetary policy just for a single country, as Britain, the US and Japan in their very different ways are currently demonstrating. 

There is a very good reason we have lurched from crisis to crisis, cobbling together makeshift policy responses as we go. The institutional framework in the eurozone is wholly inadequate to deal with a crisis of this size. Policy makers have done well just to hold the whole European project together. And note that Italy is sporting record-low post-Euro one-year yields (link in German). That, in and of itself, is a success. Yes, there are differing ideas about how strictly to adhere to the existing limitations. But all policy makers want growth. The story of intrigue at the ECB is overblown.

As Europe confronts the limitations of the single currency, we should expect the crisis to continue.