First ECB Rate Cut since May 2009

November 3, 2011

The main refinancing rate was cut by 25 basis points to 1.25%.  Very few analysts anticipated the move, which was made at the first policy meeting led by the new president, Mario Draghi.  The marginal lending rate and deposit rate also are being lowered 25 bps to 2.0% and 0.5%, respectively.  Today’s action follows rate hikes of 25 basis points each in April and July of this year and came without prior rhetorical warning.

The move is reminiscent of the abrupt about-face in 2008 when a year-long policy pause was broken in July with a 25-bp rate hike, only to be reversed three months later in the wake of the Lehman Brothers collapse.  Then, like now, ECB officials could claim that policy reversal was forced by external events.  The ECB reacted to accelerating commodity-led inflation in 2008, but the onset of the Great Global Recession reordered policy considerations.  This time, an escalating euro debt crisis has driven long-term interest rates sky high in many euro area countries.  Financial conditions are extremely difficult in the peripherals.  Greece is reported to be getting a regime change today and may leave EMU, which would undo last week’s bailout agreement and send forces of contagion to Italy, Spain and other EMU members.

The ECB can rightfully be criticized heavily for its behavior in the summer of 2008 and now.  At both times, recession, not inflation, posed the greatest threat even on a ex ante basis. 

The MIT Boys:  In a paradoxical footnote, Lucas Papademos is being reported to be the leading candidate to replace George Papandreou as Greece’s prime minister.  A former Governor of the Bank of Greece and Vice Chairman of the ECB, Papademos was born October 11, 1947 and earned a Ph.D. in economics from MIT in 1978.  Meanwhile, the new ECB President, Mario Draghi, was born five weeks before Papademos and also earned a Ph.D. in economics from MIT in 1976.  Both men studied under the Nobel prize laureate Franco Modigliani.  The fate of the world economy may lie in their hands.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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