May 19, 2024

Economix: Call for Low Rates Is Lost on Euro Zone

The European Central Bank headquarters in Frankfurt.Alex Domanski/Reuters The European Central Bank headquarters in Frankfurt.

The International Monetary Fund appeared to warn the European Central Bank on Monday against further interest rate increases, saying that the euro area is still in a fragile state. The warning may not have much effect, though. The European bank’s president, Jean-Claude Trichet, emphasized last week that the central bank will not be swayed by outside pressure.

In its World Economic Outlook published Monday, the I.M.F. suggested that there is no reason to raise the benchmark interest rate “as long as inflation pressures remain subdued.”

That is in fact the case, the report said. In most countries, factories are still not operating at capacity, while higher prices for oil and other commodities are likely to be temporary.

“This argues for low policy rates for now to support the recovery and help offset the dampening short-term effects of fiscal consolidation on domestic demand,” the report said.

Because of “financial fragilities” in the euro area, it added, the European bank should move slowly to raise official interest rates from historic lows to more normal levels.

The fund has more than an academic interest in the matter. Increases feed through to borrowing costs for Greece and Ireland, which are receiving I.M.F. aid as they try to avoid defaulting on their government debt.

The European Central Bank has already begun nudging up rates to fight nascent signs of inflation, despite widespread criticism from investors and professional economists. Last week the bank raised its benchmark rate to 1.25 percent from 1 percent.

Mr. Trichet, however, seems to almost take pride in defying the consensus and remaining true to the bank’s mandate to fight inflation above all else.

“We are used to having our own analysis and it does not necessary coincide with the analysis of some observers, some market participants, some economists and even some international institutions,” Mr. Trichet said at a news conference shortly after the bank’s governing council meeting on April 7.

Mr. Trichet maintained that the bank’s contrarian stance has served it well in the past.

“I can remember decisions we took to increase interest rates which were not recommended by any international institution,” he said. “Very fortunately now, with the benefit of hindsight, they would say: ‘Yes, you did well.’”

On Tuesday, a member of the bank’s executive board refuted one of the I.M.F.’s main justifications for keeping rates low. Jürgen Stark, who is the European bank’s de facto chief economist, was dismissive of the argument that there is no reason to worry about inflation as long as factories are operating at below capacity and there is still slack in the economy.

“Output gaps are ill-defined objects and are subject to a great deal of measurement error,” Mr. Stark said in Hong Kong, according to an official transcript of his remarks.

It wasn’t clear whether Mr. Stark was responding directly to the I.M.F. report, but the message was clear. The European Central Bank will not be told what to do.

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