ECB vs. the Fed: Is There a 'Right Way' to Handle the Credit Crunch?

The financial world is now split in two over who is right: the Fed, which decided to cut rates or the European Central Bank [ECB], which raised rates in front of the credit crunch and an imminent global slowdown.

At a time when the Federal Reserve has cut 325 basis points, the ECB has been bullish and finally decided to raise interest rates by 25 basis points. Over the same period, the Euro-area economy plunged, while on the other side of the Atlantic, things appeared to have bottomed.

However, even if the Fed and the ECB implement their decisions in the same financial markets (actually every central bank does this) they chase different objectives. The ECB’s objective is limited to assuring price stability over the medium term by way of keeping the CPI close to 2%. On the other side is the Fed, with a range of objectives from full employment to price stability and moderate long-term interest rates. From the academic part of central banking, there is a full range of research papers that say a central bank should exclusively focus on inflation targeting.

Since the two banks have different objectives, quantifying and comparing the two results is a little harder. Nevertheless, what is certain is that both banks have failed in reaching any of their objectives. The Fed has failed in securing the labor market, inflation is running wild and the economy is moving at a sluggish pace. The ECB has failed also, by not keeping inflation under control, having the CPI running twice as big as the target and second round effects are knocking on the back door.

One of the things the two banks agree on is that growth will pick up somewhere in 2009, while inflation will moderate in the coming quarters. It will be interesting to observe if this comes true, as most of the banks’ estimates, until now, have notoriously failed (Remember, “The credit crisis is contained?”). Only after seeing the coming quarters' economic results will we be able to judge who was right in their handling of the credit crunch.

Comments

[bbzz24:]

'Over the same period, the Euro-area economy plunged, while on the other side of the Atlantic, things appeared to have bottomed.'

what a nonsense!!!
uneployement is growing, credit is tighter than before, inflation is still going up and you call this bottoming out??? only because the 2 banks use different GDP deflators, the GDP numbers seem to be diverging but for how long, given the most recent dollar strength?

2008 Sep 04 12:31 PM

[attwoof:]

What amazes me is the way the market panics every time a new comment or number comes out on the credit crunch, or housing, or jobs. It's like they are hearing this for the first time,,,over, and over, and over...

2008 Sep 04 05:40 PM

[Gary Meade:]

I wonder about your statistics. With housing falling like a rock even though this is not included in CPI we are having deflation over here...not inflation.
I guess the question is which framework should we use the Keynesian or Austrian?
Did you know that our central bank that just prints money out of thin air is not authorized by our constitution? Our founding fathers understood what an inflation tax is from the clipping of coins in England!

2008 Sep 07 12:51 AM