Thursday, April 7, 2011

Eurozone: That 2% obsession

Update: Also today, the Bank of England has kept its interest rate at 0.5% in spite of 4.4% inflation. The conclusions are yours!

Is the Eurozone a victim of dogmatic economics?

Today the ECB has raised its rate from 1% to 1.25%. This may be marginally good in preserving the purchasing power of Eurozone citizen/consumer but what does it do to his/her chances of finding a job or keeping his/her job in a Eurozone company that is trying to sell products or services (eg tourism) against the expensive Euro?

Is the fixation/obsession with a 2% inflation target one of the main reasons of the problems of the Eurozone? IMO, yes. It did lead to interest rates and thus very expensive Euro for much of the 2002-2009 and still does. Even in the last 2 years, the Euro interest rate at 1% was higher than the UK's (0.5%) and of course the Fed's (0-0.25%)! Even before the increase today, the Euro has been higher than 1.40 USD/Euro.

Dear Mr. Trichet, what is so wrong re eg a 3% inflation target as opposed to the 2% one?
See some economic theory re the 2% inflation target in a recent post of mine: "Why a 2% inflation target for the Eurozone and other myths & realities!" (March 5, 2011)


So with the Euro interest rate is up 25 basis points, the US, China, non-Eurozone EU, etc exporters must be having a party to celebrate! How many Eurozone companies can compete in their own markets against US, Chinese, and even non-Eurozone EU economies (UK, Denmark, Sweden, etc) with a 1.3, 1.4, 1.5 USD/Euro rate. If the Yuan is too low for the USD, how much lower it is for a Euro that is 1.3, 1.4, 1.5 USD?

Why, why, why an interest rate increase now in the Euro, when the Fed shows no signs of moving and the inflation is driven by energy and food costs, ie these could prove temporary ones (remember the 2008 world prices crisis in staple foods and oil?)? Marketwatch.com had a very good report, IMO: "Europe leads U.S. in rate cycle — perhaps to cliff"

IMO a Treaty change is needed to make the ECB more like the Fed, ie force it to consider other factors than inflation in its rate decisions.

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Nick

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