Home > debt crisis, The Economics Profession, The Economy > Trichet’s Rein at the ECB: No Party for Europe

Trichet’s Rein at the ECB: No Party for Europe

from Dean Baker

Jean Claude Trichet will be retiring as head of the European Central Bank at the end of the month. He will step into retirement having wreaked the sort of destruction on the European economy that hostile powers can only dream about. Tens of millions of people across the eurozone countries are unemployed or underemployed because of his mismanagement of Europe’s economy. Meanwhile the world teeters on the brink of another financial crisis because of the ECB’s failure, along with the IMF, to effectively address the sovereign debt crisis. Most incredible of all, Trichet probably thinks he has done a good job.

This last point really is central because the ECB, like much of the economics profession, continues to be controlled by a bizarre clique that believes that the most important, and possibly only, goal that a central bank should pursue is a 2 percent inflation target. By this measure, the ECB has done reasonably well, even the as the euzo zone economy has crumbled around it. After all, inflation in the eurozone economies rarely exceeded 3 percent and averaged well under the 2 percent target over the last decade.

However, the low and stable eurozone inflation rate is not going to provide much help to the 21.2 percent of the Spanish work force that is unemployed or the 14.6 percent of the Irish workforce, nor the millions more elsewhere in the eurozone who have lost their jobs as a result of the collapsed of the housing bubbles that the ECB let grow unchecked.

If Trichet and his colleagues at the ECB had been awake, they would have noticed that real house prices in Spain had more than doubled between 1998 and 2006. The same was true in Ireland. There was no remotely comparable increase in rents, strongly indicating that this run-up was not being driven by the fundamentals of the housing market.

And in both countries, the massive run-up in house prices was having the predictable effect on the economy. Both countries had huge building booms and surging consumption, as homeowners spent based on their bubble-generated housing wealth. In both cases, this led to extraordinary balance of trade deficits that were clearly unsustainable for advanced economies.

How could Trichet and his colleagues have failed to have noticed these housing bubble and the economic distortions that they were creating? Or, insofar as they did notice them, did they have a theory whereby economies can seamlessly replace the 10 percentage points of GDP worth of demand, or thereabout, that was being generated by the housing bubbles in these countries?

It didn’t help that much of the rest of the eurozone also had bubbles in their housing markets (Germany was the big exception); although they were not creating quite as large distortions as in Spain and Ireland. Nor did it help matters that important non-eurozone countries, like the United States and the United Kingdom, also had bubbles in their housing market and that the whole process was being driven by over-leveraged banks.

It is very difficult to see how a central banker in the eurozone could have looked at the economic situation in 2004, 2005, or 2006 and not be concerned about the impending disaster that eventually overtook these economies. The warning signs were all over the place and flashing bright red everywhere, but rather than taking the regulatory and monetary actions necessary to deflate these bubbles – including giving clear and persistent warnings – Trichet and his colleagues focused on their 2 percent inflation target.

Remarkably, even after the collapse of the bubbles, with the eurozone economies smoldering in the wreckage, the ECB continues to be obsessed with its 2 percent inflation target. While the Federal Reserve Board lowered its overnight money rate to zero and has had several rounds of quantitative easing to try to reduce longer terms rates, the ECB never lowered its short-term rate below 1.0 percent. It actually raised it to 1.5 percent last spring in order to stem inflationary risks.

More recently, along with its troika partners the European Commission and the IMF, the ECB has had the whole euro zone financial system, and indeed the world financial system, teetering on the brink of disaster as it tries to squeeze additional concessions out of Greece and other debt-burdened economies.  While the betting is that a resolution to the debt crisis will be reached before the whole system explodes, the ECB and its partners are imposing enormous risks on everyone else for concessions that are of questionable value, at best.     

It would be tragic if Mr. Trichet is allowed to go into retirement thinking that he has done a good job. In terms of public service, Trichet’s performance ranks a notch or two below Michael Brown watching New Orleans drown when he was head of the Federal Emergency Management Agency.

Humiliating Trichet is not just a question of justice or morality; although is painful to see someone who caused so much harm escape with impunity. More importantly, it is an issue of incentives. The people given responsibility for economic policy should be held accountable for their performance. If Trichet is toasted into retirement, we have no reason to expect any better performance from his successor. That would be a real disaster.

See article on original website

  1. Andrew Jackson
    October 26, 2011 at 9:40 am

    I entirely take the point that the ECB could and should have warned of the housing bubbles. The Bank of Canada has done so here ..albeit to little effect given very low interest rates. A key solution to such bubbles is credit controls eg minimum downpayments, and tax measures tO coiunter speculation. But these are outside the remit of central banks in generaL and the ECB in particular.Trichet is guilty on the interest rate issue and he had the power of the pulpit but he could not conjure up powrs that were not his.

  2. Merijn Knibbe
    October 26, 2011 at 12:33 pm

    The ECB is the organisation which is supposed to monitor monetary and price developments in the Euro Area. And they do. Check out p. 18 of this issue (october 2007) of their ‘Monthly Bulletin’ for an, at the time, new series on indebtedness of non financial corporations and households:

    Click to access mb200710en.pdf

    Great! However. Steve Keen rightly panicked after he constructed a comparable series for Australia and looked at the outcome: exponential growth of debt as a % of GDP. Unsustainable! But what did the ECB economists do with comparable information for the EU(p. 69-84 of the same issue of the bulletin)? This:

    ” It appears that while standard macroeconomic
    determinants can adequately explain borrowing
    dynamics for a significant part of the period
    reviewed, there are episodes during which
    special factors also play a decisive role. These
    factors include structural changes related to the
    deregulation of banking markets and financial
    innovation, the shift to a low-inflation and
    credible monetary policy environment in the
    context of EMU, as well as the pronounced
    changes in income expectations during the
    IT-driven boom and bust in the equity
    Overall, general economic activity, as captured
    by GDP, appears to have been the main driver
    of loan developments in the first half of the
    review period. In the second half, however, the
    importance of this factor declined as household
    wealth assumed an increasingly prominent role.
    Against this background, an assessment of the
    strength of and developments in household
    borrowing in the past few years is inevitably
    conditional on the sustainability of asset price
    valuations, which to a large extent drive the
    evolution of household wealth.”

    That’s it. Nothing more. End of article.

    Stated differently and considering the rest of the article: “He guys, it looks like a housing bubble, it feels like a housing bubble, it smells like a housing bubble, it acts like a housing bubble, it is not driven by income growth but by deregulation of the capital market – but we should not warn because we do not know if it is a housing bubble”.

  3. Thomas Ponsard
    October 28, 2011 at 11:10 pm

    I’m not usually one to take Mr Trichet’s defence but to be honest I think you are being a bit harsh on the poor guy… He wasn’t the only one out there who was blind and oblivious to the growing risks. Is it really the ECB’s job to tell the World how bleak the future will be and what to do about it? Isn’t that the scholars’ job too? To an extent isn’t it everyone’s job? What did any of us do to stop the process? Who was bright enough to predict the collapse of the financial system to the extent we have seen? In July 2007 we had most economists in the banks telling us everything was fine and the whole “credit crunch” was just a blip. It has taken 4 years of real world recession for economists to wake up to the idea we are maybe in a long term trend. Yes, maybe, occidental countries have to realise we have to share with the rest of the World what resources there are left from the binge consumption era. It is time for deflation. We have to “rise to play a greater part”. Aiming for Dollars and Wealth is yesterday’s fight. We have to fight for Survival, Peace and Happiness. Those are the fights of tomorrow, and I do hope we see growth in our Survival chances, in the amount of Peace we can share and in the general Happiness of mankind. If we do, I’m more than happy to hand in my IPad and my Microwave oven.

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