Exchange Rate Orthodoxy and the ECB

Is continental Europe repeating mistakes made in the 1930s?:

Ominous lessons of the 1930s for Europe, by Paul De Grauwe, Commentary, Financial Times: The Great Depression taught us several lessons. ...  There is one area of policymaking where authorities may not have learned the lessons of history... During much of the 1930s ... the so-called gold bloc countries (France, Italy, Belgium, the Netherlands and Switzerland) kept their currencies pegged to gold. When in the early 1930s Great Britain and the US went off gold and devalued their currencies, the gold bloc countries found their currencies to be massively overvalued. This had the effect of depressing their exports and of prolonging the economic depression in these countries.

It is remarkable to see ... the same mistakes ... today involving some of the same countries... This time it is again the continental western European countries tied together in the eurozone that have seen their currency, the euro, become strongly overvalued. The two countries that in the 1930s responded to the crisis by devaluing their currencies, the US and the UK, today have also allowed their currencies to depreciate significantly ... against the euro...

Why do the euro area countries repeat the same policies as the gold bloc countries in the 1930s? The answer is economic orthodoxy. In the 1930s it was the orthodoxy inspired by the last vestiges of the gold standard. Today the economic orthodoxy that inspires the European Central Bank is ... the view that the foreign exchange market is better placed than the central bank to decide about the appropriate level of the exchange rate. A central bank should be concerned with keeping inflation low and not with meddling in the forex market. As a result, the ECB has not been willing to gear its monetary policy towards some exchange rate objective.

Just as in the 1930s, the euro area countries will pay a price for this orthodoxy..., a slower and more protracted recovery from the recession. ... One could object ... that the central bank is powerless to affect the exchange rate. This is a misconception. A central bank can always drive down the value of its currency by a sufficiently large increase in its supply. ... True,... the ECB has injected plenty of liquidity in the euro money markets to support the banking system. Yet it has been much more timid than the US Federal Reserve and the Bank of England... Such an imbalance in the expansion of central bank money inevitably spills over in the foreign exchange markets. ...

Ultimately a central bank has to make choices. The Fed and the Bank of England have opted for massive programmes of liquidity creation, attaching a low weight to the possible inflationary consequences... The ECB has been more conservative... The future will tell us which of these choices was right.