The ECB, Serving Europe A Diet of Diet Bundesbank

The European Central Bank cut its main interest rate to .25% on Thursday in a move that, “took financial markets by surprise“. If you had any doubt that the ECB is basically Bundesbank-lite (and if you did, respectfully, what rock have you been living under since about 2009?), that sentence should pretty conclusively erase it. So perhaps it shouldn’t be surprising to find Spiegel reporting that the move is “controversial in Germany, where editorialists warn it could affect savings and pensions“.

Humbly, I’d suggest German concerns (or perhaps more accurately, the concerns of some Germans, including influential ones like Jens Weidmann, Germany’s ECB representative) are, if not nonsense, then at least unfounded.*

Here’s what annual Eurozone inflation has been from 2001 to 2012 (all the following data is from Eurostat):

Eurozone Inflation

Germany’s the brown line in the chart; the Eurozone is the blue and green (the green is calculated to reflect its changing composition over the time frame). The ECB’s inflation target is just under 2%, and up until 2007 they were just over it instead (interestingly, Germany didn’t even breach the 2% threshold until 2007). Then oil shot up to a billion dollars a barrel in 2008 and inflation went through the roof, at least compared to the past 5+ years, hitting 3.3% for the Eurozone. Then everything went to pot in 2009, taking inflation and GDP with it:

Eurozone GDP

And it’s in this context that the ECB’s Bundesbank-lite character really comes to the fore. Faced with a similarly devastating economic contraction in 2008, the Federal Reserve moved the Fed Funds rate from 3.50% at the start of the year to 0% by the end of it, in a process that included three separate 75bps cuts. By comparison, when the bottom dropped out of Europe’s economy, the ECB took an entire year to go from 2% to 1.25%, and that included two Governing Council meetings where they actually raised their main rate by 25bps. What the !@$#!&*? The mind boggles.

Facing deflation and more than a 4% contraction in GDP, you’d think the ECB might have been able to find it in them to more robustly support the Eurozone economy. Sure, their primary mandate (see Article 2) is price stability, but deflation, huge growth in unemployment, and massive GDP contraction aren’t exactly conducive to that. And while 2011 and 2012 inflation figures for both the Eurozone and Germany clocked in above target, rampant inflation was, I think, never a serious likelihood. More importantly, on a monthly basis, from November 2012 to present the Eurozone has seen almost as many deflationary months as inflationary ones, and inflation hasn’t topped 1.2%:

2012-present Eurozone Inflation

(same key colors as before)

This is all a very long and chart-heavy way of saying that sure, if all you cared about was whether or not top-line Eurozone inflation was at its target of just under 2% then perhaps ECB interest rate policy doesn’t look like the dumbest thing ever. Another way of saying that is perhaps that if you’re German then ECB interest rate policy doesn’t look like the dumbest thing ever. I’d say this is a bit like worrying about how tidy your room is while the house burns down around you, but what do I know? At any rate, there is a strong case to be made that ECB policy to-date has been satisfying to pedants and Germans, and underresponsive to the macroeconomic plight of a substantial number of its constituents, the response to this week’s rate cut serving as confirmation.**

If the ECB really has been nothing more than Bundesbank-lite (and I think it has), what’s really going on to motivate this policy stance? Are the Germans just being flat-out selfish?*** Is Angela Merkel really willing to sell out a generation of Spaniards, Portuguese, and Greeks in order to make sure German pensioners don’t see a slight erosion to their purchasing power? Would most German policymakers and influencers in a vacuum pursue looser monetary policy, but in reality they feel constrained by domestic preferences for ruthless anti-inflation stances? Or perhaps this is just the honest result of a thorough analysis of the situation; reasonable minds can differ after all.

My hunch is that it’s not quite either of those, at least in isolation. Looming in the background is, I suspect, the oft-cited and purportedly deeply ingrained Wiemar hyperinflation-inspired aversion to any policy that could remotely be construed as inflationary. If that really is the case, it doesn’t seem like there’s a whole lot to be done about it. You can’t exactly recondition generations of technocrats, and you certainly can’t alter or erase one of the national psyche’s formative moments.

Fortunately though (if you’re Jens Wiedmann I suppose), the entire debate over ECB policy has to date taken place within acceptable limits; it’s still only a question of where to locate the Bank’s main interest rate. The real fun should begin when the ECB hits the ZLB, the Eurozone economy continues to stagnate, and the calls for nontraditional measures come in earnest.

*I mean, I doubt these guys are just making shit up for the fun of it, and to be fair they’re entirely right that long-term high inflation erodes savers’ real wealth
**Puzzling in some of the analyst commentary quoted across major news sources’ reporting of the rate cut was the notion that it was somehow good that the ECB had left itself with the flexibility to cut rates further (from .25 to 0). Considering the Eurozone economy’s been in the shitter for about four years straight, it seems like preserving that flexibility has come at a pretty high cost. On the other hand, it’s not as if hitting the ZLB months or years prior would have somehow magically fixed everything
***I’ve called out Germany in this post but at least when it comes to broad-strokes policy they’re not exactly alone; much of “Northern Europe” shares the same general set of concerns regarding monetary policy