Economist: ECB ‘underestimated risk of a double-dip’


In its fight against inflation and calls for fiscal consolidation, the European Central Bank has overestimated the strength of the economic recovery and underestimated the threat of a second recession, economist Barry Eichengreen said in an interview with EURACTIV.

The University of California at Berkeley professor argued that Europe had moved quickly towards austerity measures "partly due to economics," in the case of heavily indebted countries like Greece and Ireland, but also due to "a political phobia of budget deficits, because there is a political phobia of inflation".

The average public deficit for eurozone countries in 2010 was 6%, two thirds that of the United States' at 9%. Whereas the US Federal Reserve has set its main interest rate for loans at 0%, the lowest possible so as to encourage investment, the European Central Bank (ECB) increased its equivalent rate to 1.5% last July for fear of inflation.

Eichengreen claimed that "the ECB made a mistake" here.

'Stimulus now, austerity later'

"Specifically, it overestimated the vigour of the recovery and underestimated the danger of a double dip [recession]." Instead, he argued that "Europe would have been better served by a more accommodating policy, given how inflationary pressures earlier this year were largely transitory and the recovery is now stalling out".

He added that "a somewhat weaker currency would have flowed from that policy, and that might have helped to sustain the recovery". One euro is currently valued at 1.37 US dollars or 0.86 British pounds.

Instead, Eichengreen favours "stimulus now, austerity later".

"It is hard to imagine how a clear-eyed observer of current circumstances could see a different answer. I guess the implication is that too many policymakers have failing vision."

Towards a 'tripolar' international financial system

In the medium term, however, Eichengreen was optimistic about the euro's role in a "tripolar" international financial system also founded on the dollar and the yuan.

"With the US accounting for only 20% of the world economy, it is no longer obvious that the dollar should be involved in 85% of all foreign exchange transactions or account for more than 60% of foreign exchange reserves," he argued.

Last May, the World Bank published a report predicting that a financial system based on the dollar, euro and yuan would exist by 2025.

Eichengreen also claimed there was less of a need for a single dominant international currency due to technological changes, saying "the costs of comparing prices in different currencies has come down courtesy of smartphones and the Internet. The costs of changing money have come down courtesy of the same electronic platforms".

"Where two decades ago, technology left room for only one dominant international currency, today's technologies make it easy for multiple international currencies to coexist," he added.

He argued that since 1945 the dollar's position had eased business for internationally-oriented US banks and firms, as well as allowing the US government to borrow more cheaply.

"The US can run modestly larger currently account deficits than otherwise, and American consumers correspondingly enjoy modestly higher living standards. I add all this up, and I conclude that US living standards are 1-2% higher than they would be otherwise," he said.

However, Eichengreen warned that the failings of European policymakers were stalling the euro's rise, arguing that their inability to "resolve the crisis and the questions now being asked about the future of the euro certainly limit its attractions as an international currency".

"The incoherence of the European policy response is the main thing working in favour of the dollar's continued international role," he said.

Asked why Europeans were facing such difficulties today, the professor suggested further study would be needed. "Answering that question would require a book. And no doubt there will be books," he said.

To read the interview in full, please click here.

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