Look to Boston, not to Berlin
Published 08/06/2003 | 00:11
Look to Boston, not to Berlin THE European Central Bank (ECB) cut interest rates again last week, bringing rates in the eurozone countries to their lowest levels in half a century. The decision comes as Germany, which accounts for one third of the output of the eurozone economies, is facing its worst financial crisis since 1945.
The ECB move illustrates the difficulty the bank faces in setting a single interest rate for national economies with varying growth and inflation levels: the one-size-fits-all monetary policy. The Bank's essential remit is to subdue inflation (keeping it at or below 2 per cent), which it has managed to do. But, unlike its American counterpart, the Federal Reserve, the ECB has no broader mandate to concern itself with other economic issues, like growth rates and unemployment levels. However, with inflation now under control and with a weak dollar resulting in a strong euro at a time of European economic stagnation, clearly the ECB was under pressure to act decisively, by providing some relief.
In cutting rates by half a percentage point, the Bank, temporarily, has eased some of the competitive pressures on European business, with lower interest rates curbing the euro's rise against the dollar. The difficulties involved in setting a common monetary policy for all 12 members of the single currency, are all too readily apparent. The needs of the German economy, for low interest rates and a weaker currency to raise growth, increase exports and jobs are the opposite of those that the Irish economy requires just now.
Inflation in Ireland is more than twice the EU average, unemployment is half the German level and growth is far stronger. Accordingly, the Irish need is for higher, not lower, interest rates to ease domestic inflationary pressures, not least in the housing market where prices are now rising by some 15 per cent annually.
Since 1995, house prices have increased threefold and this country now has some of the most expensive, and overvalued, housing in the world. The EU's stability and growth pact is meant to ensure that member-state governments manage the national finances prudently. This requires balanced budgets at best and deficits no greater than 3 per cent of GDP at worst. Certainly, the pact has ensured stability. However, it has produced little growth in the major eurozone economies, Germany and France. In fact, it has been wryly described as a 'suicide pact', given its restrictive terms and its operational inflexibility. Countries like Germany that need to borrow more to offset a temporary economic downturn cannot do so. And neither can those like Ireland (with low overall national debt levels) that could, and should, borrow more for investment in infrastructure. This is clearly needed. It is easily afforded. But it is not allowed.
The EU finds itself shackled by unnecessary constraints, some agreed and some self-inflicted (like the failure by France and Germany to restructure their own economies) that are impeding Europe's own economic recovery. Once again, there is a reliance on America to act as the engine of growth and to pull the world out of recession. Except this time, it is a more difficult and riskier prospect, and there is little margin for error. Already America is running record budget and trade deficits. And last week the country recorded the highest jobless total in nine years, with six per cent now unemployed. The American administration is now using every available fiscal and monetary lever to try and jump-start the economy. Interest rates are at their lowest in half a century, with no fewer than 12 rate cuts in less than two years. The recent tax cuts are meant to boost consumption and raise investment, while the dollar has been devalued to boost exports by giving American goods a more competitive edge. For Ireland, often described as the fifty-first state of the union, and with an economy that remains highly dependent on American foreign direct investment, its future economic fortune will be shaped more by what happens in Boston than Berlin in the months ahead.