Am I being a little harsh with Jean Claude-Trichet? Perhaps, it is a hard (if not impossible) job he has on his hands. And in this post I did try hard to think about credible arguments in favour of the recent rate rise.
New arrival on the European economics blogging scene Claus Vistesen argues that the issue is about the bank gaining credibility, and that meantime we should cut Trichet some slack (in doing so, of course, he follows in the footsteps of the Economist).
But the main point Claus picks up on is this:
“Managing the financial condition of…..very diverse countries is not an easy task and trade-offs are bound to show their ugly face. The real dilemma as also reported by the Economist is that growth rates are very different across the eurozone … what to do?”
What to do, exactly? On the degree of diversity within the eurozone (which I think now is much clearer, and clearly much more resilient, than people imagined at the outset of EMU), this presentation by Paul de Grauwe is illuminating.
As the principal negative surprises de Grauwe lists:
1/. The low level of synchronisation of the business cycle. Some countries regularly boom while others are in recession. (He calls this vulnerability to asymmetric shocks).
2/. Significant differences in trend growth rates.
3/ Continuing widespread price dispersion in consumer products.
4/. Continuing structural rigidities which may be re-inforced by the availability of a general low interest rate environment regardless of progress on reform.
To these I would add:
!/. Strong variance in underlying demographic realities
2/. Lack of uniformity in the monetary transmission mechanism, which means that it is difficult to apply the ‘one size fits all’ policy as responses to changes in monetary policy show strong variance.
I could also add one more. The structural position of the euro in any dollar unwind story. New Economist directs us to a paper by Alan Ahearne and Jürgen von Hagen which argues, among other things that:
“The US current account deficit must narrow eventually and this process will almost certainly involve a significant depreciation in the dollar. The more stubbornly Asian countries refuse to adjust their exchange rates and current account surpluses, the larger will be the appreciation of the euro and the resulting deterioration in the euro area’s current account balance. The sharper the adjustment and the larger the share of this adjustment that falls on Europe, the greater the risk of deflationary pressures and a severe recession in the euro area.”
If this scenario – the significant depreciation of the dollar one – should occur, then they are right about the consequences: this would almost certainly push Germany and some other eurozone economies (eg Finland) into outright deflation. I am not sure, however, that this is the way events will unfold. More likely, I feel, is an unravelling of the government debt situation in Italy, which would cause chaos in the eurobond markets generally, and by a process of ‘contamination’ would certainly make itself felt in the US one. After that it’s anyone’s guess what happens next.
So with that comforting thought I leave you, except to say – one more time – welcome to euro-econblogging Claus.
