The European Central Bank: Bonne chance, Mr Trichet

Date: 01/11/03

A difficult, perhaps impossible, task awaits the new president of the ECB

HE HAS scarcely had the smoothest progress to the top, but now he is all but there. On November 1st Jean-Claude Trichet, head of the Bank of France, is due to succeed Wim Duisenberg as president of the European Central Bank (ECB). He has been heir-apparent for five years, following a deal (much trumpeted by the French, always denied by Mr Duisenberg) that the Dutchman would make way for him in the middle of his eight-year term. This year he had to wait while he stood trial, and was acquitted, over what he knew about the questionable accounts of Credit Lyonnais, a state-owned bank, when he ran the French treasury. The impression that Mr Trichet has been appointed as much for his nationality as for his ability should not obscure his qualities as a central banker. Just as well: in running the ECB, he will need them all.

In one respect, Mr Trichet should carry on where his predecessor leaves off. Mr Duisenberg has regularly exhorted euro-zone governments to make their economies, especially their labour markets, more flexible. Jolly good: Mr Trichet, too, cannot say this often enough. In several other ways, however, Mr Trichet's ECB must do better than Mr Duisenberg's.

Harder definition, softer policy

First and foremost is the conduct of monetary policy. Officially, the ECB's duty is to maintain “price stability”: how it defines this is for the bank itself to decide. Until recently, it said, price stability meant an inflation rate of 2% or less. Now it aims for “below but close to 2%”. By its own yardstick, the ECB has been a bit of a softie: euro-area inflation has rarely been below 2% in the past three years. However, in the world outside the Frankfurt tower, things look rather different. Although the euro area's weakness relative to America in recent years has often been exaggerated, for a year or more the zone's performance has been feeble. This has had much to do with weak domestic demand, notably in Germany, the euro area's biggest economy. Now, with the euro on an upward trend against the dollar, the zone lacks even the help of an undervalued currency. You might conclude that monetary policy, far from being too soft, has been on the tight side.

Because one interest rate must serve all 12 euro-zone countries, weak and strong alike, and because official statistics overstate inflation, there is a fair chance that the 2% goal will mean falling prices sometimes, somewhere. Mr Duisenberg seems to have cared little about this. In a currency union, he thinks, deflation in individual countries “is not a meaningful concept”. And in any case, he once said, a negative inflation rate was a “central banker's paradise”. Mr Trichet, however, should rethink - yes, again - the definition of price stability, and rethink it upwards. He should also make it clearer, by defining, as the British government has done for the Bank of England, a symmetrical range of tolerable variation.

This would help in the second area of necessary improvement: communicating the ECB's strategy to the economists, traders and others who track its every move. Granted, Mr Duisenberg got better at this towards the end of his term. Then again, having made one blunder after another at the start, he would have struggled to get any worse.

Third is the relationship between monetary and fiscal policy. To be sure, European governments will have to keep tight control of their finances in the medium term: just look at those mounting pension obligations. Yet the euro area's stability and growth pact is plain daft. It insists on deficits of less than 3% of GDP virtually all the time, even when, as now, the zone is flirting with recession. Today the pact looks more of a nonsense than ever, with France and Germany both in breach and the French in virtual contempt of it. Yet Mr Duisenberg has been a pact purist, even hinting that slack budgets might be compensated for by higher interest rates. Mr Trichet should avoid such slavish devotion.

Sorting all this out would be hard enough even without the extra, huge task due during Mr Trichet's eight-year term: the extension of the single-currency zone to more countries, mainly in central Europe, bringing its membership to two dozen or more. Setting a single interest rate for 12 countries has been hard enough, even with low inflation. Choosing one for a much more mixed bag of 20-odd may be impossible - even for a man of Mr Trichet's talents.

Editorial says that a difficult, perhaps impossible, task awaits the new president of the European Central Bank, Jean-Claude Trichet.

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