June 27, 2001
Diverging National Interests Skew European Monetary Union
By EDMUND L. ANDREWS
RANKFURT, June 22 — Jean- Claude Trichet, president of the Bank of France and a governor of the European Central Bank, provided a vivid lesson not long ago of how the European common currency has not produced a common economic viewpoint.
In words that reverberated through European financial markets in March, Mr. Trichet suggested that interest rates could come down because the central bank was no longer very worried about inflation.
Ten days later, after the bank did not cut rates, Mr. Trichet retreated. Looking like a man doing penance for his sins, he read a statement from the central bank's president, Wim Duisenberg, at a meeting of top finance officials from Germany and France.
The bank "confirms its position of wait and see," Mr. Trichet read aloud, without elaborating. Fighting inflation was still the bank's primary objective, and it remained worried about the ripple effects of higher oil prices.
Mr. Trichet's pullback reflected more than being chastised for a slip of the tongue. A growing number of analysts say it showed just how deep economic divisions run in Europe. And it conveyed the European Central Bank's own structural limitations, as well.
In the United States, the Federal Reserve has reduced interest rates five times this year and is expected to do so again shortly. By contrast, the European bank first promised to hold interest rates steady, then startled the markets with a small cut, and now is once again holding rates steady.
Is the central bank putting on the brakes or pressing on the gas?
Mr. Duisenberg, in an interview at the bank's headquarters here, acknowledged that people might be confused. "I don't deny that it is not an easy strategy to communicate," he said. But he insisted that it was not intended to be puzzling.
"It is not our policy to surprise markets," Mr. Duisenberg said. "By explaining our strategy and by explaining our decisions, we want to be as predictable and unsurprising as possible."
That may not be possible. The 12- nation euro zone is being pulled in opposite directions. In big countries, like Germany and Italy, growth has slowed to a crawl. In smaller ones, like the Netherlands and Ireland, growth is stronger but inflation is running at the highest rates in years.
That would be a conundrum for any institution. But many experts argue that the bank's overarching goal of keeping inflation below 2 percent a year is too rigid.
Others argue that the bank has been hobbled by its quest for consensus. Its 18-member board of governors includes the presidents of all 12 national central banks, and Mr. Duisenberg has made clear that he would prefer no decision to one favored by only a slim majority.
"Maybe it is peculiar, but I try to forge a consensus," he said. "If a discussion were to lead to a narrow majority, then it is more likely that I would postpone a decision."
These have been trying times for Mr. Duisenberg. With little more than six months left before euro bills and coins are introduced into general use, the European common currency is floundering against the dollar. Euros, which began trading in electronic form two and a half years ago, have lost about one-quarter of their value against the dollar. When the central bank tried to shore up the exchange value by intervening in the currency markets last fall, the effect was negligible.
The last few months have been particularly messy. Long after most private economists had lowered their 2001 forecasts for European growth, the central bank remained publicly confident. And just as it finally did start trimming its forecast, consumer prices began rising more than expected.
In March, Mr. Trichet and other top officials baffled analysts by suggesting that the time had come for a rate cut, and then by reversing themselves. "A few months ago, we were very, very worried about inflation," Mr. Trichet remarked before falling into line with Mr. Duisenberg. "Not any more."
But on May 10, the bank seemed to reverse course again. Just as Mr. Duisenberg had persuaded market analysts that the bank would not relax rates, he announced a quarter- point cut in the benchmark short- term interest rate, to 4.5 percent.
He said the bank was merely making a technical adjustment, because it had refined its statistics on the money supply. Few believed him at the time, and the governing board has met three times since and declined to cut rates further.
A growing number of critics argue that the bank's structure and approach have limited its flexibility.
Friedrich Heinemann, an economist at the Center for European Economic Research in Mannheim, Germany, said that the bank's decision- making power is skewed toward smaller countries and that right now, those countries are worried more about inflation than a slowdown.
"Measured by gross domestic product, Germany is 150 times bigger than Luxembourg," Mr. Heinemann remarked. "But when it comes to decision-making, they each get one vote. In general, the smaller countries have faster growth and higher inflation than the bigger countries. So they are naturally much less interested in reducing interest rates to promote more growth."
By contrast, the inflation rate in France was most recently 2.5 percent, with joblessness running at 8.5 percent. In Germany, there was 3.6 percent inflation and 7.7 percent unemployment.
The relatively higher inflation of smaller countries, in economic terms, is not too disturbing for Europe as a whole. In political terms, it can have a big impact.
Mr. Duisenberg recalled a conversation two years ago with the central banker of a booming small nation. Mr. Duisenberg wanted to cut rates then because he was worried about a severe economic slowdown. "I called and told him to expect a proposal on cutting interest rates at the next meeting," Mr. Duisenberg said. The banker's first reaction, he recalled, was: "Oh, no! Not in my country, too?"
Partly to help the European Central Bank project a unified front, Mr. Duisenberg labors hard to build enough consensus that votes are unnecessary.
"I am not a C.E.O.," he said. "I am chairman in the governing council. Therefore, I see it as my first task to forge that team spirit."
Thus far, he said, the members had formally voted only twice and those were on technical issues rather than basic monetary policy. "There hasn't always been unanimity," he said, "but it was always clear that a very large majority agreed."
But outside analysts say that the insistence on building consensus makes it hard to reach decisions. "It is not only that the group is large," said Jose
Other critics say the European Central Bank has adopted an overly rigid approach. Its self-imposed goal of keeping inflation below 2 percent is more restrictive than that of the Bank of England or the Federal Reserve.
The hard line is a legacy of the German central bank, which serves as the model for the European institution and which has placed top priority on preventing inflation.
But many European economists, including a growing number of Germans, now say that the standard is too tough. Mr. Alzola noted that incomes and prices in countries like Ireland and Portugal are simply catching up with their wealthy big neighbors, so higher inflation rates are almost inevitable.
"If you restrict inflation in those countries to less than 2 percent," he said, "then it means countries like Germany, with a naturally lower rate of inflation, would have a rate of closer to 1 percent. That is flirting with deflation."
This month, two leading German institutes that advise the government on economic policy called for a more relaxed approach to interest rates. But there have been few pleas for lower rates in most other European countries.
Another matter at issue is the central bank's practice of basing decisions on the growth in the money supply. That approach is also a direct inheritance of the Germans, and is based on the conviction that inflation is ultimately a result of printing too much money.
In central bank parlance, money- supply growth and expectations about inflation are the two "pillars" of monetary policy.
But a recent report by the Center for European Policy Studies, a research group in Brussels, concludes that the central bank's data on money supply is too fuzzy to be reliable.
The bank itself acknowledged a problem in May. In cutting interest rates, the reason it gave was that it had refined its money-supply data, to include the large amounts of money held by people outside the European Union.
According to Mr. Duisenberg, the revisions showed that the money supply had grown much more slowly than previously thought. "We believe our monetary statistics are the best that we can lay our hands on," he said, "but even these statistics are constantly being reviewed." (The Fed long ago abandoned basing policy primarily on changes in the money supply.)
Daniel Gros, chairman of the Center for European Policy Studies, said the problems would not be solved so easily.
"It is quite strange that the E.C.B. has said the statistics on which it based its decisions are wrong," Mr. Gros said, "while on the other hand saying they won't change their approach at all."
Norbert Walter, chief economist at Deutsche Bank Research, said the European bank had a much bigger problem with euros held outside the area than the Bundesbank ever had with German marks held abroad.
As if all that were not enough, Mr. Duisenberg is entangled in a messy political battle over his plans for retirement. When European leaders named him president in 1998, shortly before the introduction of the euro, the French demanded that he agree to retire after four years so that Mr. Trichet could take his place for the remaining four years of the term.
Mr. Duisenberg insists that he made no promises and that the decision is his alone. French leaders are getting impatient. If Mr. Duisenberg refuses to budge, the French — who are accustomed to playing a leading role in every European organization — might find themselves left out more than they feel already.
Mr. Duisenberg refused to discuss his plans. "If you asked me," he said, "I wouldn't say anything."