The Economist on the ECB-correct facts (at last!)-confused theories

July 15, 2005 3:15 PM by Stefan Karlsson | Other posts by Stefan Karlsson | Comments (4)

For months I have been pointing out ( See also this post )that the widespread perception that the European Central Bank (the ECB) has pursued a "tight monetary policy" is a myth. Later Paul Kasriel of Northern Trust also pointed this out.

But now for the first time, a major "mainstream" publication, The Economist , has rejected the myth. In this article as well as a leader unavailable online to non-subscribers they point out that measured by consumer price inflation, real interest rates and money supply growth, policy remains very loose.

Considering that The Economist have in fact been among the people who until recently have attacked the ECB for pursuing a overly tight monetary policy it is very interesting too see that they have now changed their mind. It's probably one of those summer interns now running the show who takes the opportunity to implicitly criticize the regular writers who are on vacation.

Another good thing about the article is that it points out that the official measure of consumer price inflation probably underestimates inflation.

Unfortunately though, the article is also filled with very confused economic theories. In fact, it contains more economic fallacies than any single article I have read for a long time.

First of all they use nonsensical Keynesian concepts such as the output gap and the Taylor rule for monetary policy (which is partially based on the output gap).

They then point out the need for structural reform in Europe, but they seem to regard lowering taxes and welfare spending and deregulating the labor market as a secondary priority at best, only to then claim that "The snag is that in the short run reforms that reduce job protection are more likely to depress consumer spending."

As if the key to economic growth was consumption. In reality it is of course investments, and in order to have a sustainable increase in investments higher savings is of course needed. This anti-savings nonsense is however not really new to The Economist, who last year criticized China for not spending more tax payers money on health care something which allegedly held back growth as people saved more in order to have enough money to be able to buy health care when they need it. That China like had the highest growth rate in the world as a result of having the highest savings- and investment rate remained unnoticed.

Similarly their main idea for "structural reform" is to increase the possibility of using homes as ATM-machines through "home equity loans" the way it is possible in America. Which is to say, even though they previously noted the high money supply and credit growth they do favor higher money supply growth only through increased home equity loans rather than formal base rate cuts.

Contradicting themselves in a similar way in the end they blame the ECB for being partly to "blame" for the alleged excessive thrift of Europeans when the ECB point out that they already pursue a inflationary monetary policy so they can hardly do much more to boost growth. This they claim makes Europeans to pessimistic and hence too thrifty. But the whole point of the article was that the ECB was right when it cannot do much more to boost growth so are they supposed to lie and say they can? And won't such a lie appear extremely puzzling to say the least if they don't follow up and do cut rates?

Another contradiction appear when they after having spent the article pointing out that it would be unwise to cut interest rates given how money supply growth and consumer price inflation is well above what they should be, they suddenly say rates should be cut in order to "cushion economies when reforms [Reforms? What reforms?] are being carried out". A turn justified by claiming that "core inflation" is low (forgetting how they previously in the article pointed out how the official measure underestimates inflation).

As if all of this wasn't bad enough they also criticize European governments for not running large enough budget deficits. That several of them including the three biggest economies, Germany, France and Italy already run budget deficits even greater than in America relative to GDP seems irrelevant.