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Vaidas sent me an interview with ECB board member Benoit Coeure. Here’s the sort of quotation that I’ve made fun of in the past:

On the definition of medium term: “There is an academic definition of ‘medium term’ which is the Milton Friedman definition. That’s 18 months. But it has always been recognized by the ECB, from inception, that the path through which inflation reverts back to the 2 percent number depends on the nature of the shock and it depends on the type of nominal rigidities that you have in the economy. In the current situation, where you have this enormous structural adjustment going on and enormous deleveraging pressures that are obviously weighing a lot on prices, contributing to the subdued price pressures, it is only normal that we see inflation coming back more slowly to the medium term objective. That’s compounded by the fact that a number of European countries are going through a relative price adjustment which is a necessary adjustment, since it’s part of regaining competitiveness. This is temporary, and should not be confused with deflation. Mechanically, this relative price adjustment weighs down on the average euro-zone inflation number. For all these reasons, inflationary pressures will be very subdued for an extended period of time. The definition of medium term is probably more extended now than it could have been in other circumstances because of the situation the euro area economy is in. And we have to acknowledge it.”

It’s hard to imagine an American macroeconomist saying it’s healthy for inflation to be running below target because the economy is so weak. On second thought . . .

At least it would be correct to say that Paul Krugman and many other American pundits have picked on the ECB for making statements like this in the past. So what could be going on here?

It occurred to me that this is exactly the sort of thing that people at the Fed used to say in the first few decades of its operation, when it hadn’t yet figured out what it was doing. We went from a classical gold standard to a managed gold standard to Bretton Woods to a pure fiat regime, and each time a new approach to monetary policy was needed. Often the Fed was stuck in its old way of thinking, old rules of thumb, and did not rise to the challenge.

You might assume that the Europeans already had plenty of central banking experience, so the ECB should have done fine. But perhaps that’s exactly the problem. They had lots of experience, but of the wrong kind. Maybe they thought that running the ECB would be like running the central bank of a small open economy, whereas it’s more like running the central bank of a large closed economy. More like the Fed. But over in the eurozone they don’t yet realize that fact. They are running years behind the Fed in figuring out how to do things.

Think about what’s wrong with that quotation. The emphasis on weak economies cutting costs. That’s not a bad way of looking at things when you run a central bank in a small open economy, and need to make your economy more competitive. In that setting, however, when things get way out of line you devalue—that’s how you make the domestic economy competitive. But the individual members of the eurozone no longer have the ability to devalue, and the ECB doesn’t seem to realize that the only way for the eurozone as a whole to become more “competitive” is to raise the inflation rate. Counterintuitive, but true.

PS. I have a new post at Econlog.

PPS. Marcus Nunes has a post on a different Coeure interview.

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This entry was posted on January 17th, 2014 and is filed under Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



