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Thursday, March 16, 2006

Will the ECB Abandon Its Monetarist Tradition?

Change at the European Central Bank:

How the loss of an ECB pivot will be felt, by Ralph Atkins, Financial Times: ...Otmar Issing, the European Central Bank’s chief economist, who steps down in May. ... has played a pivotal role since the ECB was established in the late 1990s as the central bank of Europe’s monetary union. For the past eight years, he has guided its economic thinking and the successful switch from national currencies to a stable and strong euro. “He made it actually work,” declares Adam Posen, of the Washington-based Institute for International Economics.

So does his departure herald a big shake-up for the ECB? Do not expect a revolution – this is a central bank, after all. ... It is a moment of historical as well as economic significance. The departure of the German-born and -educated monetarist ... breaks the link between the ECB’s executive board and the once-revered Bundesbank, on which the pan-European institution is largely modelled. ... Mr Issing bequeathed to the ECB not only that institution’s gravitas and market credibility but also its approach to managing the economy.

As at the German institution, Mr Issing has been the guiding spirit behind the monetary “pillar” of the ECB’s strategy, with its focus on monetary aggregates such as M3, the broad money supply measure. The ECB’s adherence to such yardsticks puts it out of step with most other central banks...

Jean-Claude Trichet, the ECB’s president ... will be quick to reassure ... that no cracks will appear ... after Mr Issing leaves. He may also stress his own monetarist instincts and those of the ECB’s rate-setting governing council. ... Mr Trichet has little choice but to stress continuity and stability ... Any hint of changes to its “two pillar” strategy – in which the analysis of real economy variables such as gross domestic product growth is “cross-checked” against the monetary “pillar” – would risk the credibility that it has established ...

Jürgen Stark, vice-president of the Bundesbank, has already been chosen to succeed him. But the expectation in Frankfurt is that Mr Stark ... may not be handed Mr Issing’s brief in its entirety. At least part of the economics portfolio may be transferred to Lucas Papademos, the former Greek central bank governor who is the ECB’s vice-president... He is arguably more in tune with international mainstream economic thinking, in which monetary aggregates play less of a role. ...

Ideas previously considered taboo have started to creep into discussions. An important example is the concept of “output gaps” – the degree of slack in an economy, which indicates whether monetary policy is appropriate. Mr Issing regarded such ideas as too vague and dependent on unreliable data. But Mr Papademos was influential in developing the concept. ...

Some in Frankfurt expect a more mainstream economic emphasis in future... Over time, such thinking could shape policy, possibly making it appear less “hawkish” – although hardened German monetarists claim the bank is already too lax...

    Posted by on Thursday, March 16, 2006 at 12:48 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (27)

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