The case for looser monetary policy should be clear when the European Central Bank governing council convenes in Frankfurt on Thursday. The question is what tools to use: lower interest rates, spraying the banks with more cheap long-term money or the ECB’s first dose of “quantitative easing”. The answer should be a mixture of all three.
Mind you, there are enough inflation hawks inside the governing council that it’s not certain it will even agree that more needs to be done. Some central bankers may argue monetary policy is already loose enough. After all, the ECB’s main interest rate is 0.5% and back in July the central bank said, in its first experiment with “forward guidance”, that it expected interest rates to “remain at present or lower levels for an extended period of time”.
What’s more, the euro zone is gradually recovering. In the second quarter, GDP rose 0.3% compared to the previous quarter. As if this were not enough, Germany’s Bundesbank has started warning that property prices are getting overvalued in some German cities. Why stoke an emerging bubble with still cheaper money?
There are two answers to these points. First, the ECB’s monetary policy should look to the needs of the euro zone as a whole, not just at what is happening in a few German cities. Insofar as the Bundesbank is concerned about a property boom at home, it should advise the German authorities to tell banks to curb their mortgage lending in those areas prone to inflation. There’s no need to deny the rest of the euro zone a looser monetary policy.
The second answer is that the euro zone’s recovery is anemic. As Mario Draghi, the ECB president, put it last month, the governing council itself views the recovery “as weak, as fragile, as uneven”.
There are several problems. One is that credit flows are, in Draghi’s words, “very weak”. Another is that the appreciation of the exchange rate will make it harder for European companies to enjoy export-led growth. Ten days ago, the euro rose to $1.38—a near two-year high—before slipping back on expectations of a rate-cut.
If inflation was also high, the ECB might be justified in taking no further action. But it’s not. Eurostat’s flash estimate for October was just 0.7%, down from 1.1% the previous month. Every month this year, inflation has been 2% or less.
The drop in inflation is partly due to falling energy prices and