Meanwhile, in Europe (12). Deconstructing Trichet

Published on Real-World Economics Review Blog, by Merijn Knibbe, April 25, 2011.

Introduction. Recently, mr. Trichet, head of the European Central Bank (ECB), raised the Euro-interest rate to an historical still low 1,25%. But considering the state of the economy, this 1,25% rate might still be quite high:

  • Looking at it from the Keynesian point of view there still is quite an output gap. Unemployment (U-3) is 9,9%, construction is at 75% of pre-crisis levels and still declining and industrial production is still not back at 2007 levels. Also, restrictions on intra-EU labor mobility are rapidly waning (no, Keynesian thinking is not anathema to supply side thinking, increased labor mobility in fact increases the output gap). 
  • Looking at it from the monetarist point of view we see that money growth (M1 and M3), though slightly higher than last year, is, with about 2 to 3%, still way below targeted nominal GDP growth (and therewith deflationary)
  • Looking at it from the post-Keynesian/accounting point of view, we see that balance sheets of households, companies and governments still show massive private debts – a risk to the economy, surely when inflation goes down and interest rates go up (and yes: a post-Keynesian economist is a Keynesian economist who knows accounting)
  • Looking at it from the economic history point of view we have to investigate the possibility of a ‘Danube-miracle’, high economic growth which will raise very low eastern European hourly wage rates (3,60 in Estonia against 20,07 in Ireland) – as price levels in these countries will adapt to German levels this genuine growth will however show up as an increase in the price level
  • Looking at it from the radical/libertarian point of view, the ECB may well be an instrument to guarantee the (banking) interests of the mightier states, instead of an impartial body which wisely agrees on the best rate possible.

This means that there are sound reasons to investigate if Trichet was right to raise the interest level. Below, I’ll analyze the “introductory statement to the press conference” which accompanied the interest hike to investigate the ideas of Trichet and his economists. First, however, a prelude.

Prelude: central bankers can be wrong: … (full text).

Link: Also on the Real-World Economics Review Blog: IMF’s Welcome Rethink on Capital Controls, by Kevin P. Gallagher, April 26, 2011.

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