TIME EUROPE
MARCH 20, 2000 VOL. 155 NO. 11
VIEWPOINT
Don't Shoot the Pianist
The European Central Bank should not be blamed for the euro's weakness
By KLAUS FRIEDRICH
The european central bank can't do anything right--at least according to its critics. They charge that it is not only too opaque its decision making, but that it also does a bad job of communicating its intentions. All this allegedly leads to confusion in the marketplace and causes the euro to perform feebly against other major currencies. Certainly, the euro's recent bout of weakness--in which at one point its value fell as low as 93¢--is troubling. But does that mean that the critics are right?
A frequent criticism--especially by British and American commentators--focuses on the E.C.B.'s alleged lack of transparency. Specifically, these critics want the central bank to do three things: make monetary strategy more predictable, publish the minutes of all E.C.B. Council meetings and give inflation forecasts. There are sound economic arguments to back up any of these demands but also good arguments to do things differently. In pleading their case, however, these critics very selectively use the procedures of selected other central banks to fit their argument.
For example, the E.C.B. uses two broad measures--the growth in the money supply and future expectations of inflation--to set monetary policy. Opponents label this strategy as too discretionary and point out that the Bundesbank used to target only the money supply. Conveniently, these same critics overlook the fact that the U.S. Federal Reserve has in the recent past used everything from the unemployment rate to stock prices as indicators when setting monetary policy. Thus, it has far more flexibility in this regard than the E.C.B. and nobody seems too upset about this. By the same token, critics laud the Bank of England for publishing inflation forecasts, and expect the E.C.B. to do the same. However, while singling out the E.C.B., they make no mention of the fact that neither the Bundesbank nor the Fed make such forecasts public.
And just because the Fed publishes the minutes of all meetings at which interest rates are set, there are calls for the E.C.B. to do so as well. But the same people argue that the E.C.B. does a poor job of communicating its intentions and thinking to the markets and that it needs to speak with a more unified voice. These critics do not explain how publishing meeting minutes which, after all, would put a spotlight on each and every detail that council members disagree on would further that goal. In addition, the Fed hardly speaks only through Alan Greenspan. Members of the Fed have not hesitated in the past from publicly disagreeing with Greenspan on a number of important issues.
The inconsistencies in the arguments of the E.C.B.'s critics are not surprising. To have a single central bank set interest rates for 11 sovereign nations has never been done before, and the E.C.B. will have to find its own way to handle this situation. There is no ready-made framework that the E.C.B. could easily adopt. Whenever there is a new kid on the block, especially if it's a major presence like the E.C.B., the market participants need a while to get to know each other. Over time, as the E.C.B. builds a track record, the markets will learn to better understand its intentions.
So far, the E.C.B. has done a very good job of focusing on price stability--an approach that is both transparent and credible. It is right to treat the euro's exchange rate as a secondary concern. Intervention in the foreign exchange markets to support the euro could have a disastrous impact on the E.C.B.'s credibility. If inflation remains in check in the euro zone, then the euro will be a strong currency over the medium to long run. Many people still forget that inflation in Europe currently is significantly lower than in the U.S.
One has to wonder what the E.C.B.'s critics expect. Unemployment in Europe is going down, growth is strong and accelerating, and the euro's exchange rate is appropriate for the current macroeconomic situation. For the time being, Europeans can live comfortably with the euro at or near parity with the dollar. Past experience with the deutsche mark-dollar exchange rate indicates that there is a time lag of at least half a year before accelerating economic growth has an impact. Applied to the euro, this means that despite the improving economic outlook, it may be summer or early fall before there is a turnaround in the euro's fortunes.
Despite all the recriminations, the euro has been a spectacular success as a financial instrument, and the E.C.B. has begun the process of creating a strong, reputable institution. It has done an excellent job of navigating the difficult problems created by the gap between expectations and reality in the foreign exchange market. It never let this gap affect its real mission, which is to keep inflation tame. That is the ultimate test of a central bank--a test the E.C.B. has so far passed with flying colors.
Klaus Friedrich is chief economist of the Dresdner Bank in Frankfurt
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