Interesting Interpretation of Trichet’s Comments Regarding ECB Policy
Eurointelligence cites a Die Zeit interview (the original interview here) with ECB central bank President Jean-Claude Trichet. Their take on it is quite interesting, which suggests that most are ‘wrong’ about the path of ECB policy. According to Eurointelligence:
Central bankers are trained not to say anything of any relevance in long speeches or interviews, and Jean-Claude Trichet is a master at this. So we were a little surprised when he told Die Zeit that governments should fine tune their fiscal policy in the fight against inflation. Here is the quote: “Individual countries must accept the monetary policy as a given and adjust their national policies accordingly…When a country experiences a boom, it needs to make its own national policies …more restrictive in order to avoid the economy overheating or speculation getting out of control.” The policy consensus has been for the last few decades that monetary policy is the instrument of choice to control inflation and inflation expectation, while fiscal policy should be oriented towards medium-term goals. Fiscal policy has a role to play in countries that overheat relative to the rest of the eurozone – like Spain before the crisis – but this is hardly applicable now. (If you consider Germany as overheating, there is not much you can do with fiscal policy to constrain the inflationary pressures, especially considering the time lags through which fiscal policy operates. We interpret Trichet’s statement as saying: monetary policy is currently constrained, so fiscal policy is all we have got. This is quite extraordinary, and makes us wonder whether the ECB is really determined to prevent an upward drift in inflation.)
RW: This could be a very astute representation of Trichet’s comments: that fiscal policy should be the main tool to target inflation expectations to the upside if the ECB feels they are taking care of the downside! The implication is that the ECB is ‘on hold’ for much longer than markets expect. Today, for example, the Eonia forward swap curve (the Eonia rate is the Euopean equivalent of the federal funds interbank rate) has 25 bps in ECB rate hikes priced in through August 2011, 50 bps through the December. The Eurointelligence interpretation of Trichet’s comments would suggest that this is way off, that the ECB is on hold for some time.
There are several caveats to consider regarding the ECB’s policy stance: (1) As I’ve argued before, German wage pressures are bound to get a bit frothy this year, which may challenge the ECB’s resolve. If those pressures are more robust than history demonstrates - I argue that they will – a new ECB president would be less accommodative in its policy response than Trichet implies… (2) …which brings me to my next caveat: Trichet’s term as ECB President ends in October 2011. His successor – the most likely candidate at this time is Mario Draghi – will then take the monetary policy scepter. Will he/she hit the ground running? Better put: will he/she hike rates right out of the gate if German inflation and/or commodity price inflation is perking up? (3) The ECB has been known to jump the gun with regards to commodity prices. Trichet, in his February policy statement, reiterated that he expects near-term price inflation to see its fair share of time above 2%; this suggests that he may have learned his lesson in 2008 (see this post regarding the ECB’s reactionary policy).
Originally published at Angry Bear and reproduced here with permission.