Hawks and Doves Series #4

084dacfe-2e0c-42fc-96af-94b37518a67fDi Sofia Bernardini.

In the next two weeks, both the European Central Bank and the Federal Reserve will have meetings. Are there possibilities of changes in European or American monetary policy? On the eve of these events, we asked Professor Donato Masciandaro what the possible scenarios are.This March, the most important monetary policy appointments are approaching: the BCE press conference this week, the FED’s one next week. Are there any similarities and/or differences between the two?

Yes, there are both similarities and differences. The similarity is a sort of paradox: there is an improvement in macroeconomic conditions in both regions, Europe and the USA, which means better performances both in terms of output growth and inflation. The paradox is that the better is the performance, the more possibilities of conflict between politicians and central banks increase. This is a common feature and I will explain it more in detail by comparing the EU and US situation later on. The first difference is that from an institutional point of view, the ECB’s position is stronger than the position of FED. This is mainly due to two reasons: on the one hand, the ECB does not front only one policy maker, but many policy makers. This phenomenon strengthens the ECB’s position, although it may seem the opposite. On the other hand, the US has only one commander in chief, who has been particularly aggressive so far. The second difference is that the ECB’s monetary policy strategy is defined in terms of monetary rules and so tight hands is usually a very effective tool. This is not true for the US; the FED has not had a monetary rule to follow and this has been weakening the FED’s position so far.

Let’s focus on the Eurozone. What does the economic situation look like and what do you expect from this week ECB’s conference?

Europe is characterized by an improvement in macroeconomic conditions, inflation is coming back to normal level, close but below 2%. The issue is that this situation could create some problems to one European Country: Germany.  Indeed, in Germany there is political pressure to change the European economic stance and, on top of all, in Germany there will be political elections this year. As a result, from a German point of view is it easy to imagine that there will be a discussion about the need of normalizing monetary policy in Europe. I guess that in this occasion there will be no explicit change in the monetary policy stance. One feature, the inflation rate in Germany, is not sufficient to implement new measures, to do so the ECB needs trends. We don’t have significant inflation rate trends, at least not yet.

What about the US economics status? Is there a strong possibility of increasing interest rates during the FED conference on the 14th-15th?

Yes, there is an increasing probability that the FED will decide to change the monetary policy stance, increasing the interest rates, perhaps by 25 percent basis points. The economic reasons in favour of this change are the followings: the American economy is in very good health, inflation is going towards 2% and full employment is almost reached. However, as well as in the EU, in the USA there is a political problem: President Trump announced a very aggressive fiscal policy, in terms of lower taxation and higher expenditures. This procyclical policy, an expansive fiscal policy in a moment of economic boom, pushes the FED to increase interest tax rates. Thus, in the USA there could be a conflict between monetary policy and fiscal policy. It is likely to see tension between the monetary policy and Mr. Trump’s goals. How harsh could this tension be? It is difficult to figure it out, it will depend on which cards President Trump will play. He can have a double nature, as the main character of Stevenson’s novel “Strange case of Dr Jekyll and Mr Hyde”. If he decides to be an aggressive President, then it will be likely to see a war between the Central Bank and the Presidency. If he behaves in an institutional way, it will be more likely that his choices in matter of fiscal policy will be more consistent to the ones of the previous Presidents, that respected the FED’s independence. We will wait and see.


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