Is German dominance causing suboptimal monetary policy for the Eurozone?

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German dominance over the ECB is nowhere more apparent than in the price stability goal of inflation at or below 2% that is enshrined in the Maastricht Treaty. The price stability mandate of the ECB was an important element of Germany’s willingness to sign up to monetary union and this is a goal still deemed paramount to German policy makers and the general public in the execution of ECB monetary policy. However, just as this focus on price stability has been criticised in the past as being to the detriment of growth and jobs in Europe,[1] it is the subject of much debate now, resulting from divergent inflation trends between the core and periphery of the Eurozone.[2]

While the core, and in particular Germany, is experiencing strong growth and the risk of inflation increases, peripheral economies, such as Greece and Ireland have yet to resume growth since the onset of recession in late 2008. Nonetheless, the ECB raised its key interest rates by 25 basis points to 1.25% following its April meeting, which prompted criticism from economists who saw the move as damaging to the Eurozone’s periphery and/or too timid to address rising inflation in the core, depending on perspective.[3] It seems safe to say, then, that the ‘one-size-fits-all’ monetary policy of the ECB is more nearly ‘one-size-fits-none’ at this point.

Neither I, nor any other sane person, would suggest that it is a simple task to identify a ‘one-size-fits-all’ monetary policy for the Eurozone at the best of times, not least in the midst of the current debt crisis. However, it is still worth asking whether a more meaningful debate over the appropriate direction for ECB policy could take place in the absence of German dominance.[4] For example, should the ECB focus less on discrete price changes and more on inflation inertia? Should the average inflation be weighted differently than it currently is? Should the bank have a dual-mandate (price stability and full-employment)?

[1] See Ardy, B., Begg, I., Hodson, D., Maher, I., & Mayes, D. G. (2006) Adjusting to EMU (Basingstoke: Palgrave).

[2] See Financial Times (7/4/2011), ‘Trichet Defends ECB Rate Increase’ at http://www.ft.com/cms/s/0/e4c95f16-6143-11e0-ab25-00144feab49a.html#axzz1MtvwdFOH

[3] See Spiegel Online International (3/5/2011), ‘Risks of Economic Overheating: German Boom Fuels Inflation Angst’ at http://www.spiegel.de/international/business/0,1518,760105,00.html

[4] See Financial Times (26/4/2011), ‘ECB Looks Set for Tough New Style’ at http://www.ft.com/cms/s/0/f2201956-7030-11e0-bea7-00144feabdc0,s01=1.html#axzz1MtvwdFOH

 

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