The European Central Bank is widely expected to cut interest rates, perhaps by 50 basis points (half of a percentage point), this week. They could, of course, follow the lead of the Bank of England or the Swiss National Bank and go for a much larger cut (150 basis points and 100 basis points respectively on their most recent rounds). But they probably won’t and not because the economic outlook in the eurozone looks so different from those other parts of Europe or because the the ECB’s Governing Council knows something we don’t or because their interest rates are already low (actually, at 3.25%, they are definitely on the high side.)
The difference really lies in two factors: extreme views about inflation, and the nature of decision-making within the ECB. Belief that a resurgence of inflation is always imminent is, of course, Germanic but not limited to Germany. Within the 15 central banks represented on the ECB’s Governing Council, there will always be at least one or two who see unions as looking for an excuse to push up wages. We can debate whether or not this view is correct under today’s circumstances, but that is irrelevant – these inflation hawks still appear to strongly hold such beliefs.
Of course, there are inflation hawks among all groups that make monetary policy. But the consensus-seeking process at the ECB is such that even just a few such people can serve as an effective brake on rapid action. The existence of such views has plainly not prevented the ECB from taking dramatic action on some fronts (e.g., in terms of liquidity provision the ECB arguably moved farther and faster than the Fed last year), but for core monetary policy issues – i.e., when the price stability “mission” is at stake – a couple of outliers can really slow things down (particularly if one or more are members of the Executive Board.)
if the ECB puts through a fairly standard interest rate cut, then it is Business As Usual in the eurozone. Combined with the rather anemic (or largely smoke and mirrrors) fiscal stimulus in the EU, on top of Europe’s well-known labor market inflexibility (i.e., it is hard to reduce your wage costs, even if business turns down sharply), then the eurozone is in for a rough ride.
If the ECB surprises the market with a dramatic interest rate cut, at least we will know they are firmly in catch-up mode. But even then, I’m afraid it is probably too late to have much effect on the recession in 2009. Under the best of circumstances, interest rate moves affect the real economy with a lag of at least a year. And the current disruption in the credit market is far from helping monetary policy be effective.
While we will no doubt look back on this crisis as having its epicenter in the U.S., it’s the lack of coherent policy response (monetary, fiscal, regulatory) in Europe over the past year that has really helped turn this into a sustained global crisis.