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Expansion with a safety catch Samuel Brittan The Financial Times 10/06/05 M Jean-Claude Trichet, President, European Central Bank M le Président, Open letters are best avoided. Perhaps I can plead as an excuse our past friendly conversations in Paris and my belief that there is a modest way in which you can contribute to the strengthening of European institutions and the European economy after the "shock" of the rejection of the proposed constitution by two core members. The drop in the euro's external value will hardly be enough in the present context to jack up the European economy. There is a strong case for an early cut in the ECB's interest rates; and I hope that my putting this conclusion first will not prevent you from reading further. I was encouraged that at your last press conference you at least did not deny that the possibility of a cut had been discussed. You put some emphasis on the fear that a cut in short-term interest rates might trigger an increase in long-term ones. There are economists who take an opposite view: for instance the Goldman Sachs London team, whose head, David Walton, has deservedly been appointed to the Bank of England's monetary policy committee. My view, which I suspect is also yours, is that everything depends on how a cut would be perceived. To reveal the plot now: it would best be seen as a reaction to the abnormally low rate of increase of nominal gross domestic product in the eurozone. Nominal GDP is simply GDP before correcting for price changes. It is approximately the sum of real growth plus inflation. Given an inflation target of just below 2 per cent, normal growth for nominal GDP should be somewhere between 4 and 5 per cent per annum. It was in this range during the period when monetary union was being established from 1997 to 2001 inclusive. But since then it has been much less - between 2½ and 3¾ per cent. Of course, the main European economic problems are structural; or - as you once said before taking up your present post - labour costs are too high. No tinkering with monetary policy can remove this weakness. But it can help remove any element of demand deficiency and perhaps create a climate more favourable to structural reform. Some reforms, while beneficial to employment in the long run, can have a short-term impact in shaking out uneconomic jobs. An assurance that flexibility in labour costs will in the not too distant future be reflected in more growth and jobs could help. Nominal GDP was a hobbyhorse of mine during the early British debates on monetary policy. I have gone quiet on advocating it in the UK partly because the British version of inflation targets has so far worked surprisingly well in delivering real as well as nominal stability. UK nominal GDP growth has remained almost entirely within a stable corridor of 4½ to 6 per cent since Bank independence. Secondly, the focus of attention has shifted to boom and bust in asset markets, which cannot be easily addressed in terms of flow variables. Asset bubbles have been less important in generating fluctuations in the eurozone than in the English-speaking economies. Moreover, nominal GDP is technically not quite the right measure of nominal demand for an economy such as America's or the UK's that has a large structural payments deficit. By contrast, the eurozone need not worry on this front. You have urged European consumers to take advantage of the stability climate to increase their purchases. This is in contrast to Otmar Issing, the ECB's chief economist. You seem to doubt, however, whether policy actions by the ECB can stimulate consumption. If cheaper money really did stir up inflationary fears, it would surely encourage consumers to spend now before their incomes and savings had lost value. But I believe my proposal would minimise the risk. I would respectfully ask you to glance at the speeches by Ben Bernanke, formerly of the US Federal Reserve and now chairman of the Council of Economic Advisers. He argues that a central bank, which is responsible for monetary creation, can always remedy a spending deficiency. A British chancellor once told me that nominal GDP lacked sex appeal, by which he meant that it would be difficult to put over in a lively way. But is this really so? In the British context it could have been introduced as a national cash objective. A monetarist such as Mr Issing should be able to see it as a velocity adjusted monetary objective. And to a Keynesian, it can be presented as demand management with a safety catch to ensure that demand expansion does not support ever rising inflation. Of course no one can guarantee results from the slight adjustment of course that I am advocating. But it would at least make it tactically more difficult to treat the ECB as a scapegoat and would establish beyond doubt that eurozone problems are not due to "deflationary" bias on its part.
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