That "Curious Incident" is a GREAT headline. Cleverly moves us from the Gold Standard to the Silver Blaze Standard. Love it.

As to the ECB itself, well, let's get back to talking about your great intro, or anything else that is upbeat.

Central bank independence is a good thing - within limits. The ECB has too much independence. The Fed has a much more growth oriented culture - thank God.

That's incredible. The stability pact forced euro-area countries to forgo fiscal policy, and now Duisenberg says that it's not appropriate to use monetary policy to stimulate the economy. What does that leave? The growth fairies?

Nigel Hawthorne, the ECB has an explicit inflation target of < 2%. How is that more independence than the Fed?

Julian Elson

>the ECB has an explicit inflation target of < 2%. How is that more independence than the Fed?

The ECB's adopted inflation target is self-imposed - and could therefore be changed by the ECB itself if appropriate. However, my clear impression is that the ECB feels its credibility would be challenged if the target appeared to become flexible under political pressure. The target is already being challenged by the UK from outside the Euro Area on the grounds that the target is asymmetric and also because, unlike the Bank of England, the ECB does not publish minutes of the meetings at which rate decisions are made or the voting record of its board members.

The Euro Area's Stability and Growth Pact is also currently being breached by Portugal and threatened by the size of Germany's fiscal deficit. On top of that, if only to judge from the rhetoric of the ECB's president, Duisenberg, the bank's clear diagnosis is that the Euro Area's unemployment and GDP growth problems are attributable to insufficient progress in (market) "structural reform" by some national governments, not deficiency of aggregate monetary demand, so now is not considered an opportune time to flex the target when the average inflation rate across the Eurozone is just above the 2% limit and therefore running twice as high as the UK's inflation rate as measured on the same official HICP price index. By reports in the news, the Bundesbank president has come out in support of the ECB's decision to keep its refnancing rate at 3.25% for the present.

My guess is that the ECB's inflation target an' all would likely become bargaining counters in the context of whether the UK might join the Euro Area next year once HM Treasury's assessment of its famous "Five Tests" for joining is completed. A recent poll of economists in City of London banks reported a substantial majority saying they believed the tests would fail. However, the NIESR, a highly rated independent think-tank, was among the small minority reporting that it believed a pass on the tests was a likely outcome.

If any want to dig deeper in this, I have just found the locations of two important recent ECB reports on:

Financial Structures (2002)
http://www.ecb.int/pub/pdf/reportfinancialstructures2002en.pdf

The Single Monetary Policy in the Euro Area (April 2002)
http://www.ecb.int/pub/pdf/gendoc2002en.pdf

Bob Briant writes:
"The target is already being challenged by the UK from outside the Euro Area on the grounds that the target is asymmetric and also because, unlike the Bank of England, the ECB does not publish minutes of the meetings at which rate decisions are made or the voting record of its board members."

- I think the lack of insight is one of the major problems regarding both ECB and the EU. Everything is decided behind locked doors and the possibility for average citizens and journalists to "monitor" politicans within the EU is hardly not existing. From my experience this is why so many Northern Europeans have a negative attitude towards the Union, it is impossible to monitor corruption or ill-behaving politicians. From my background as a Scandinavian this is a shock, where insight into political decisions are among the "best" in the western world. Southern and Central Europeans have generally no acceptance or understanding of this, and the other way around of course. Cultural clashes, once again. The ECB needs to change--> less independence & extend focus to more than inflation.

Mikael S, Milan, Italy.

Central Banks do need political independence but the secrecy of the ECB and the excessive removal from political responsibility may come to be viewed as signal problems if the economic weakness of the Euro countries continues as the ECB "waits."

It's important, in my view, to remember that in European affairs political and social concerns tend to dominate over economic considerations. I've mentioned here before that the Versailles Treaty of 1919 was a classic example of just that with ultimately tragic consequences. The early drive to push through monetary union in the early 1990s to speed the process of European integration is another. For those old enough to recall these things, Hallstein, the first president of the European Commission (1958-67), was fond of saying: "We are in politics, not business."

Of course some recognised that there would be problems with monetary union from economic disparities within Europe, from the absence of fiscal stabilisers on a continental scale and from underdeveloped political structures to co-ordinate fiscal and monetary policy. The hope and expectation was that the challenge of events would promote the evolution of European institutions to find solutions. The decision of the ECB to hold its refinancing rate at 3.25% needs to be seen in this context.

European political leaders know well enough the case for market reforms, not least because Tony Blair has often told them so and because the OECD Jobs Study, intended as a catalyst, was produced back in 1994. But they know too that many such reforms will be hugely unpopular with electorates. There is the European game of each government making very sure its country doesn't appear to lose out in relation to its neighbours for fear the party in official opposition will turn that into a leading campaign issue at the next election. That is how democracy works. The ECB's position that rates need to be kept on hold to apply pressure on national governments lagging in market reforms is familiar but when it comes down to unwinding the European Social Model the choice is clear.

In Europe, social security, shorter working hours and longer holidays are apt to be rated higher in popular preferences over pursuit of economic progress as measured by GDP. After all, the large majority of those who want work are in jobs. There are as yet few sufficiently powerful incentives to push the pace of market reforms. Indeed, under pressure from proposals by the EU Commission, national governments will approve directives for market liberalisation measures and then fail to implement, very likely amid effusions of political rhetoric about European integration. In the last resort, the pressing need for tax harmonisation can be wheeled out again - it just has been - to thoroughly obscure the issues and, by implication, pillory those countries regarded as the principal culprits in resisting that. As they say, The struggle continues. And so do the hidden agendas.

Hello Bob, here we are again.

>>Of course some recognised that there would be problems with monetary union from economic disparities within Europe......The hope and expectation was that the challenge of events would promote the evolution of European institutions to find solutions.<<

Maybe the problem is not the lack of institutions, but something deeper. One of the intellectual driving forces for the Euro seems to have been some sort of convergence theory, based on an apparent stylised fact concerning conditional converge among broadly similar economies, or on the convergence of regional outliers to national growth rates and living standards. It was therefore assumed that the stragglers would getto enter into the main group. This doesn't seem to be happening. One of the reasons for this could be the complete lack of homogeneity in the workforce, and the absence of a European-wide labour market 'stirring process' to begin to reduce the differences. According to OECD figures the working age population of Spain and Portugal have an average of around 8.5 years of education while in France and Germany the relevant figure is around 12.5. This situation is being compounded by the ageing population and immigration, with the relatively better educated immigrants heading north. One new labour market entrant in 3 (and this will soon converge to 1 in 2) here in Spain is an immigrant, and the average education is about 6 years of schooling. In other words the human capital component of the Spanish labour force is likely moving down at this time.

At the same time the Spanish inflation rate remains stubbornly 2 percentage points above the German one. Conclusion: in a not too distant time horizon Spain can have the same labour costs as Germany, but not the same work force. Solutions?

This situation is compounded by the admission of 10 new EU (but non-Euro) participants. These countries will retain control of their exchange and interest rates, and hence have a comparative advantage over their Mediterranean rivals (remember the New Trade Theory anyone). Bottom line: FDI goes East. This is already being noticed here in Spain - Volkswagen, for eg, is threatening to transfer SEAT to Bratislava. With an overvalued currency (in the specific case of Spain, and inflationary tendencies, the balance of trade simply deteriorates, and absent available remedies continues deteriorating. This is why I keep mentioning Argentina, not to be alarmist but to raise the point that any Euro exit process, if and when it comes (and I think when is the more likely bet) will be extremely messy and complicated. Didn't anyone else notice that divorce is always a more emotionally complicated process than marriage.

>>Yet they could steps to make sure that interest rate cuts and structural reform are complements, not substitutes<<

I'm not sure which steps you are referring to here Brad. They are flagging the problem pretty strongly at present, and as central bank governors it's not clear to me what else they might do.

On the more substantive point, many commentators criticise the bank suggesting that it is not sufficiently responsive to public opinion.(Obviously Duisenbergs obscurantism doesn't help here). In fact the opposite situation really would be a problem.

Duisenberg faces three tough problems. One is credibility - his, that of the bank, and that of the Euro. The second one is really being able to measure consequences, as he says in the press release, uncertainty about the future is very high right now, and even if it weren't the capacity of the central bank to predict changes in inflation and unemployment is nowhere near as extensive as is popularly imagined. (The Blinder book on your reading list is pretty good on this). And thirdly, there is the fact that the EU economies are far from homogenous.

If we start from the idea that what matters are real, not nominal interest rates. Then since Germany has 1% inflation (and dropping), the ECB rate of 3.25%represents a real rate of 2% - far two high. Spain, on the other hand, has an inflation rate of 3.5%, thus the real rate in Spain is -0.25%, ludicrously low for a country with a chronic inflation problem.

The present rate is bad for both countries. So what do you do, raise or lower, take your pick? Obviously depending on whether you're German or Spanish you may take a different view. And if you are Irish or Italian, or Dutch or French. Why, oh why, you may well ask, did anybody dream up the idea of the Euro in the first place?

Edward
>Maybe the problem is not the lack of institutions, but something deeper. One of the intellectual driving forces for the Euro seems to have been some sort of convergence theory, based on an apparent stylised fact concerning conditional converge among broadly similar economies, or on the convergence of regional outliers to national growth rates and living standards.

As far as I can gather, consideration of "some sort of convergence theory" was a secondary concern in the political lobbying for monetary union in Europe. Doubtless, researchers in the Commission and more did read up on the conditions for an optimal currency area but sufficient "convergence" among EU economies in due course was more or less assumed.

The Werner Report of 1970 was an early plan for monetary union in Europe but what really quickened the pace was France's unhappy experience with an unstable Franc at the beginning of Mitterrand's long presidency from May 1981 through to May 1995. His election in 1981 was followed by assembly elections in June which brought in a leftist majority and a government committed to a socialist programme of reflation, to boost employment, along with state ownership of the "commanding heights". That had barely got underway when speculation against the Franc mounted a pace or two. In consequence, the Franc was devalued in October 1981, and again in June 1982 and March 1983 when the government then felt obliged to reverse course in economic policy and apply an austerity programme instead. A vision of the Strong Franc was spun after the spate of international currency realignments from autumn 1985 through early 1987.

It was that experience of the Franc in crisis which lead Mitterrand to conclude that socialism in one country in the European "Common Market" - as it was then generally called - couldn't work. The outcome was that Delors was lined up for the Presidency of the European Commission, which he duly took on in January 1985 with an agreement behind the scenes to roll out the European Single Market and then monetary union. Lord Cockfield, one of Britain's commissioners in that Commission reshuffle, was made responsible for European legislation on the "internal market", starting with a White Paper in June 1985. A second report, paving the way for monetary union, was produced in 1988 by a committee of experts under the chairmanship of Ceccini with the inspiring title: 1992: The European Challenge. The downstream result was the Maastricht Treaty of 1992 for Economic and Monetary Union in Europe leading to the European Monetary Institute in 1994, then the creation of the European Central Bank in 1998 and the launch of the Euro on 1 January 1999.

Of course, the Ceccini Report of 1988, as well as much other relating literature, concluded that monetary union would be mutually beneficial to participating member states for a now familiar string of reasons - lower transactions costs and avoidance of currency risks on intra-union trade, better cross-border price transparency leading to more intense competition, greater scale economies from a larger internal market and, possibly, the sovereign benefits accruing if the Euro becomes a key international currency. But much of that literature is relatively sparse on what constitutes sufficient convergence for monetary union and, more especially, on adjustment mechansisms of national economies to external disequilibria.

Such disequilibria are balance of payment problems by another name. Contrary to some popular beliefs, those don't evaporate with monetary union - they become manifest as what we normally regard as "regional disparities", albeit possibly on a national scale with monetary union through loss of monetary autonomy and particularly if the currency of a participating member gets locked in at an over-valued exchange rate. However, the whole professional literature on "open economy macroeconomics" - in which the "irrevocably fixed exchange rates" of monetary union is a special case - has been developing at a ferocious pace during the last ten years. We will likely agree, much of that will be thoroughly opaque to the average Europhile enthusiast. Indeed, my experience elsewhere from around a couple of years back is that standard macroeconomic textbook discussion of adjustment problems in the European monetary union had not then percolated to parts of the Commission - which might just have something to do with the fact that the Brit who headed the monetary policy unit in the Commission got fired in 1995 for making critical comments about the Euro project. Some regarded that as heresy - quite literally.

As I believe you have been pointing out elsewhere, the recent economic catastrophe in Argentina is the eventual unintended consequence of a decision in the early 1990s to "irrevocably" fix the exchange rate of the Argentine Peso to the US Dollar, undertaken then as an anti-inflationary measure with the very best of original intentions. Of course, some political corruption and burgeoning fiscal deficits made their own contributions to the catastrophe but then those factors are not entirely unknown factors in Europe either. All of which helps explain why more than just the odd eccentric national government in the Eurozone is not instantly overjoyed at the prospect of scrapping the Stability and Growth Pact that went with monetary union in Europe.

Another intriguing aspect to all this is how the political left in Europe over the last 20 year, a few dynosaurs apart, has transformed from being a leading focus of continuing opposition to the Common Market - as "a capitalist club" or a prototype for "Fortress Europe" - into becoming the most ardent exponents of the claimed benefits from complete economic and political integration. Just what induced that Damascene conversion? Is it due, as both political cycnics and realists might suppose, a refound enthusiasm for dirigisme applied on a grand scale?

As to Mr Briant's notion that resistance to political pressure is what held the ECB off from easing last week, it is beginning to look like ECB members want to have and eat their cake. Issing today said that last week's decision was the most difficult in the 4-year history of the Bank. Since there had been a good bit of official pressure for an ease prior to the meeting, a difficult decision that came down on the side of standing pat may have been a signal to politicians. Issing's comments also suggest that, with just a tiny bit of cover (ZEW index falling off a cliff today), the ECB may now feel able to do the right thing and ease. Oh, by the way, inflationary pressure has apparently disappeared over the medium term (says Issing), after keeping the ECB from easing just a few days ago.

>it is beginning to look like ECB members want to have and eat their cake.

There are moments when I too tend to believe that eating a cake and having is almost a universal aspiration in European politics but then I conclude it does little harm so long as it remains only an aspiration. Personally, I am inclined to worry more when some appear to want to issue a European Directive revoking the Law of the Excluded Middle on the grounds that it is an unwarranted restriction on freedom of expression and therefore an infingement of human rights.

More seriously, Plato's notion of ideal forms and an abiding conviction that humankind is perfectability have had a continuing and destructive influence through European history for centuries. Remember that Roberspierre, during the French revolution, wanted to institute the "virtuous society" so it naturally followed that any critics of his proposal were opposed to virtue and could therefore be justly guillotined to secure a more virtuous society. That political model has had many imitators. On the other hand, the notion of inevitable trade-offs in policy options has been slow to percolate. In public debates on monetary union, proponents will seldom concede that there could be any possible drawbacks to a single currency. From extensive personal experience in other places, even to suggest there could be is apt to incite a barrage of invective, which is hardly conducive to making rational judgements.