Feldstein on Contrasting ECB and Fed Credit Stances

August 8, 2008

Professor Martin Feldstein of Harvard, mentor to generations of influential economists including Fed Chairman Bernanke, argues in an Op-Ed piece in the Financial Times today, that the very different credit policy strategies of the ECB and FOMC this year are each appropriate despite similar growth and price trends in the two economies.  He justifies the ECB’s more restrictive stance on three factors: “the power of Europe’s unions, its history of hyperinflation, and the need to develop credibility for a young institution.”  Because of each of those issues, the ECB has less margin for error in conducting a monetary policy that takes any chances with inflation.  A fourth factor related to the first one is, in my opinion, the lower productivity growth rate found in Europe, which translates into a weaker non-inflationary speed limit there.  There is considerable merit in Professor Feldstein’s points. 

A still unanswered question, nonetheless, is whether the ECB or the Fed has run a better policy.  Each may have pursued an appropriate course, but like the pigs in Animal Farm, one of the strategies may have been more appropriate than the other.  Currency movements since exactly one year ago, the infamous day when the era of global financial dysfunction began, may hold the answer, and it suggests that the ECB did a better job even as the Fed did a respectable job.  Compared to August 8, 2007, the dollar has lost 9.5% against the Swiss franc, 8.1% against the euro, and 8.0% against the yen.  Currencies do not always rise concurrently with rising interest rates or depreciate when rates are declining.  The more consistent connection between changing short-term rates and currency movement is that that currencies perform best when credit policy is considered situationally appropriate.  Dollar depreciation during the past year implies greater investor confidence with the policy pursued by the ECB than by the Fed.

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