Dealing with the crisis on the Continent
Charles Goodhart is professor emeritus of banking and finance at the London School of Economics and an expert on European monetary policy. He spoke to The Times about Europe’s handling of the economic crisis and the role of the European Central Bank, which joined Wednesday with central banks around the world in lowering interest rates. It was the ECB’s first rate decrease in five years, from 4.25% to 3.75%, after keeping the rate elevated to ward off inflation.
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Should Wednesday’s interest rate cut have been greater?
Interest rates are going to go on going down. And if one is so confident that interest rates are going to go down further, then why not do more now? There are a number of answers to that. One is that we still have inflation well over target. Another is if you get too far ahead of the market, you’ll be accused of panicking. People will say, “Well, my God, if they had to cut 2%, it must be very dreadful out there.” The third thing is if you’re operating on your own, and you have a big current account deficit, you will find the exchange rate working against you.
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Would a bigger rate cut by the ECB or in Britain have been counterproductive?
If the U.K. had gone down 100 [basis points, or 1 percentage point] by itself, and everyone else was going down by 50, it would have suggested that the U.K. authorities thought the U.K. was in far worse position than everyone else, and it would have caused a sharp fall in sterling. . . . There has been a lot of criticism in Europe of the U.S. for having cut the rates so much faster, along the lines that it didn’t do much good.
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Over the last few weeks, the ECB has repeatedly made more money available to European banks and has now cut the interest rate. Are these piecemeal and stopgap measures?
I think the ECB would rather take the opposite line. The ECB would argue that this has really been a crisis connected with liquidity, and what they have done is they have systematically made liquidity much more quickly and more reasonably available than the Bank of England, for example. Given the inflationary pressures in the world, it was right to keep interest rates up. They would criticize the [U.S. Federal Reserve] as not having done enough to expand liquidity and doing too much on interest rates.
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Couldn’t you say that the ECB has been too focused on inflation?
One has the splendid advantage of hindsight. I think that you could certainly say that once one had reached the panic stages of the last two to three weeks, that you had to shift balance toward trying to prevent an economic depression and the likely deflation that might go with it. Again if you were asking Europeans and the ECB, they would say that the crucial step and indeed the crucial mistake was allowing Lehman Bros. to default, and that changed what had been a pervasive and difficult liquidity problem and generalized lack of confidence into an outright panic. It’s a European view.
I think the American view is that the ECB are a group of old Germanic Prussians who focus solely on inflation targeting and can’t see the world in front of their eyes, and the European view is that the Americans systematically took the wrong steps at the wrong time. They didn’t provide enough liquidity and they panicked over interest rates and it didn’t help them. No doubt the truth lies somewhere in between.
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One British columnist said that “inflation is yesterday’s problem.” Do you agree?
Inflation is not tomorrow’s problem because of what has happened, but it’s going very much to be the problem the week after tomorrow.
What I mean is that the recession is going to be sufficiently serious that the central banks around the world have got to lower interest rates, perhaps even lower than in 2001; they’ve got to flood the world with liquidity.
When the world recovers . . . there will be an absolute seabed of massive inflation. We’ve got to handle the crisis first and do whatever it takes to do that, but the resolution of the crisis is going to leave our economic systems absolutely at risk against future massive inflation.
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When it comes down to a crunch like this, do the central banks of individual European countries have more clout than the ECB?
No, as far as it comes to monetary policy. The problem here is that there is no ministry of finance or fiscal authority behind the ECB.
When it comes to financial stability issues, it often depends on having taxpayer money at hand, and there is no source of such money at the European level.
The only money available is at the national level, the nation-state’s money.
What you’ve seen therefore with the attempts to bail the banks out is that it’s all at the nation-state level. There hasn’t been anything undertaken at the European level.
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We’ve heard many vague pledges in the last few days of European cooperation. Is further European cooperation actually possible?
This is actually a very interesting juncture, because it’s been very clear in this crisis that there’s a kind of fault line where monetary policy is done at the European level, except the U.K., but there’s no equivalent fiscal centralization. As a result, financial stability cannot be done at the European level. It goes back to the nation-state level.
Given that demonstration, and the fact that it is generally felt on a wider political level that European coordination has failed in this case so far . . . there is a fear that either the whole sort of system of having a single financial system in Europe may take a number of steps backward. . . . People had just been hopeful this fault line wouldn’t prove too troublesome, and this crisis has shown that it is troublesome.
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Is some sort of fiscal authority for the ECB the answer?
There’s a division within Europe. There are quite a lot of people and countries that would like to move further toward deeper political and economic union who would be happy to see greater centralization in fiscal competencies.
But there are other countries, particularly the richer countries, who feel any centralization of fiscal policies would be a comparatively heavy burden on their own people. This is particularly the Germans, the British, to an extent the northern Europeans. . . . The choice of that is strictly political.
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Will the British bailout package and any similar ones to follow by other European countries be enough?
Yes, I think so. If the central banks carry out the kind of expansionary policies that they will now carry out, we’ll get through. It won’t be comfortable. It’ll be two years in which standards of living will decline in most countries, including the U.S. and Europe, but if central banks and ministries of finance do the right thing, it won’t be significantly worse than 1992 or ’73 and ’75.
We’ve already got to a stage where the crisis is such that a recession is inevitable. But it needn’t be a depression. Effectively it means central banks cut interest rates, ministries of finance allow the automatic stabilizers to bring about a considerable increase in the state of deficits, debt-income ratios are allowed to rise significantly, and bailouts bring about a restoration of confidence.
But remember, the problem after that is that the measures necessary to deal with this crisis will lead to inflation further down the road. But one problem at a time.
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