Thursday, January 14, 2010

How long will the ECB remain independent?

During the run-up to monetary union, the Germans would only agree to exchange the DM for the euro if they were assured that member states would not be able to pressure the ECB to inflate. They got what they wanted: Europe is now governed by an apolitical, unelected, "independent" central bank that is hawkish on inflation, dovish on deflation and oblivious to growth or employment: a blue-eyed BoJ. 

Clearly this arrangement has been a bad thing for peripheral Europe, where low interest rates fueled a debt-financed boom/bust and which today has no ability to devalue or fight deflation. 

But today's paper reports that Germany's GDP shrank by 5% in 2009, which raises the question as to whether the ECB isn't bad for core Europe as well. Certainly this has been the French view for some time. 

By its own admission the ECB is undershooting its inflation target, and it is certainly not delivering economic growth or full employment. How would it rate its performance against any set of objective criteria? Are deflation, stagnation and high unemployment exogenous phenomena, like bad weather or bad luck? 

I predict that before this cycle is over, there will be a major debate over the ECB's governance and the political relationship between the ECB and the Commission. With growth of negative 5%, maybe even the Germans will come around.

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