Posted by: Dirk | April 26, 2012

The responsibility of the European Central Bank

Mario Draghi, president of the European Central Bank, held a speech in March that ends like this:

Let me conclude. The euro area’s performance in the global economy is good, but continuous adjustment is needed to keep up in a highly dynamic international environment.

Within the euro area, a number of countries need to repair and strengthen their competitiveness for the sake of their own continued prosperity and the overall stability of our economic and monetary union. This process requires going to the root of the loss of competitiveness, tackling its sources and enhancing the opportunities for growth.

The time frame of this correction will differ according to the degree of the imbalances and countries’ overall economic conditions. But in times of severe financial constraints, there is no other choice than to address the structural losses in competitiveness in an urgent and decisive manner.

What monetary policy can do for competitiveness is to ensure price stability in the euro area, reducing risk premia and making sure that all the transmission channels of the monetary impulse do work.

I would add that the markets clearly understand that. Thus, continued price stability, unencumbered credit markets, fiscal consolidation and structural reforms that decisively address the issue of insufficient growth stemming from loss of competitiveness would bring about an increase in confidence. And, as I am sure we all understand, increased confidence will further contribute to Europe’s recovery and to our longer-term potential for growth, jobs and continued prosperity.

Now I would have a question. Why did price levels increase so much in the periphery (Portugal, Ireland, Greece, Spain)? Was it

a. the opposite of austerity: government spending expanded and drove price levels up (source)

… or:

b. the expansion of loans in the periphery under the watch of the ECB:

The ECB did some things right in the crisis, mostly by breaking the rules. If it wants to survive, it needs to break more rules and stop relying on failed policies like inflation-targeting and failed institutions like the stability and growth pact.

And sure you can keep talking about confidence if you want to make sure that large parts of Europe enter a lost decade in full confidence. However, that will only be a footnote in the history books of the future. Those that want them to be European textbooks should think again.


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