Surviving the slowdown

Responsible for monetary policy in one of the world's largest economic areas, the European Central Bank (ECB) comes under intense public scrutiny. The ECB acts on behalf of all euro area members, who have diverse traditions and differing views about the conduct of monetary policy. The ECB is accountable to the European Parliament, whose overseeing role in monetary policy is recently acquired. For all these reasons, it is important to provide regular, rigorous, non-partisan and pan-European analysis of monetary policy in the euro area. Monitoring the European Central Bank I (MECB) addresses this need. Written by a team of distinguished academic economists, known internationally for their work in this field, each year MECB produces a spring report and an autumn update. In 2001 the ECB faced a sharp deterioration in the economic outlook, both globally and in the euro area. MECB 4 describes the challenge for monetary policy and assesses the ECB response. Interest rates fell much less in the euro area than in the US. It is often argued that the ECB cut interest rates both too little and too late. Does this stand up to serious scrutiny? Or should we infer instead that the Fed responded too vigorously, or that the extent of the problem was simply larger in the US? The principal conclusion of MECB 4 is that the problem was larger in the US. There is some evidence that the ECB was slow to cut interest rates, but that by late 2001 it had made up lost ground. A Fed-in-Frankfurt would not have cut interest rates more, but might have cut them earlier. Given adverse supply shocks in 2000, the ECB sensibly let inflation exceed its target. When demand projections then declined sharply in 2001, the ECB probably had little choice but to delay interest rate cuts until actual inflation was seen to have peaked. With a longer track record of success, and greater clarity about how its decisions are made, it may one day be able to act more decisively in advance of events. Two changes would enhance clarity. First, the monetary pillar looks increasingly ridiculous, giving perverse signals that the ECB probably ignores. It needs demolition, not cosmetic improvement. Second, having sometimes, but not usually, coordinated its monetary decisions with other central banks, the ECB should now spell out when coordination is appropriate and when it is not.