Politicians like scapegoats. There is no shortage of candidates. The European Central Bank is among them especially in France. It is unsurprising for several reasons: it is a bank, it is in Frankfurt, and a general lack of economic understanding mean that the electorate has limited knowledge of a central bank’s role and how it should act. As a result, the ECB’s positive effect on eurozone growth since 2001 is being completely overlooked.
The ECB is not obsessed with its objective of price stability. It acted pragmatically by reducing its refinancing rate to 2% and then holding it for 29 consecutive months even though inflation was above 2%, long-term bond yields were hitting historical lows, public deficits were expanding and the euro remained substantially undervalued. During this period, real short-term interest rates were zero or even negative. This policy led to a 60% increase in lending to French households, which is hard to square with claims of a restrictive attitude. Without the ECB’s accommodative policy, the eurozone’s growth – averaging 1.5% per year between 2002 and 2006 – would have been even weaker, by more than half a percentage point. Econometric analysis shows very clearly that the ECB places just as much importance on the economic cycle as the US Federal Reserve. Even today, the ECB is not adopting a restrictive policy, instead moving back to a neutral stance. By doing so, it is regaining some room for manoeuvre that could come in useful in the event of a negative shock.
Its monetary strategy is especially remarkable given the relative stability of eurozone prices. This shows that price stability – the objective assigned to the ECB by European governments – is not incompatible with growth. Nostalgia for the “trente glorieuses” – the 30-year period after World War II when growth and inflation coexisted in France – has led some people to hope for the return of inflation. They are forgetting the high interest rates during this period. Although inflation is now low, so are interest rates, and this is underpinning purchasing power and the ability to borrow long-term. Control over inflation increases visibility over relative price movements and improves the allocation of resources. The credibility of monetary authorities and a firm anchoring of expectations make it easier to attain the objective of overall price stability without having to raise interest rates too high. Conversely, doubts over the central bank’s independence and its commitment to price stability would prompt lenders to demand higher returns to compensate for the increased risk. This would push up interest rates, inevitably dragging down growth given the open economy and extensive use of market financing.
Neither can the ECB be accused of ignoring exchange rates. It is true that the euro is allowed to float, and started the decade seriously undervalued, without the ECB intervening. However, contrary to received wisdom, the ECB does take exchange rates into account. It does so indirectly through its inflation target, since a stronger euro puts downward pressure on prices, prompting it to set lower interest rates. It also does so in a more direct way: the euro’s effective exchange rate plays a significant role in its reaction function, which describes the way it sets its refinancing rate.
French politicians are keen to attack the ECB because they know how much lending growth has boosted growth and supported job creation. They know that the inevitable slowdown in lending will change the situation and require new economic policies. This will involve innovation incentives, but also greater competition in the services sector. Productivity in services must grow more quickly if per-capita wealth is to increase. However, this would require changes to the existing set-up, which is harder than simply criticising the European Central Bank. However, the resulting increase in purchasing power would be much greater.