Mario Monti – former European commissioner for the EU internal market – is interviewed in the FT today. On the recent ECB decision to raise interest rates he has this to say:
“Critics of the ECB say its monetary policy has been too restrictive. Mr Monti disagrees but says â€œthere is an institutional credibility to be gained in the infancy of an institution. For a central bank, that is gained if you err on the restrictive, rather than the permissive side.â€
Yesterdayâ€™s rate increase â€œis likely to avoid a weakening of that perception of credibility, and is likely to reduce the need for further increases in the very short termâ€, he said.”
I don’t entirely agree with him, but this is a reasonable explanation. I agree that you couldn’t exactly call recent ECB policy too restrictive. You really can only sustain that position if you think that what Germany really needs is a sustained dose of Japanese-style ZIRP (but to do this you would have to undo monetary union in my opinion, EMU wasn’t constructed with this type of problem in mind). We may get to this situation, but we aren’t their yet. Hence there is a plan b available, which is try to continue offering a bit of something for everyone.
In this context M. Monti is concerned about bank credibility, but he also makes a more subtle point: that a quick rise now buys time, and takes off the pressure for subsequent rises in the short term. As I say, I don’t entirely buy this, but at least it is a coherent argument.