Issing backs single monetary policy

European Central Bank chief economist Otmar Issing defended a single monetary policy for the diverse economies of the eurozone, saying in a speech released on Saturday it is too simplistic to argue that inflation and growth rates are widening. Inflation expectations are low across the region, competitive forces are at work and risk is shared across borders - all factors that smooth out the impact of divergent inflation and growth rates in the 12-nation region, he said. Issing's remarks, delivered to an international monetary conference, were a partial rebuttal to European Union finance ministers who last weekend called diverging growth rates a worrisome problem for the 12-nation eurozone.
With the economies in Italy and the Netherlands slumping and Germany struggling to get back onto a solid growth path, increasingly politicians and economists are voicing concern over how well monetary union works for their economies.
If the growth gap widens and inflation rates diverge in the 12-nation area, it makes setting a one-size-fits-all monetary policy far harder. It would mean that a given interest rate would be wrong for a majority of countries most of the time.
High inflation countries like Ireland or Spain for instance experience low real interest rates, fuelling high domestic demand and more growth, while the mirror image happens in low inflation countries such as Germany.
"However, such a simple analysis neglects several important factors," Issing said in his speech delivered Friday night for release on Saturday.
Firstly, a better way of measuring the effective interest rate that applies to a eurozone country is to subtract inflation expectations, not the reported government inflation number, from the price of money, he said. Afterall, inflation expectations are the driving factor in economic decision making not reported inflation.
When this is done the real interest rate gap among eurozone countries is less, hence the impact on growth mitigated. Data show that since 1999 when monetary union began, long-term rates adjusted for inflation expectations give a real interest rate that is half the level of that rates are adjusted for government price data, he said.
"Due to the commitment to a credible monetary policy to the achievement of price stability, the dispersion of national inflation expectations in the euro area is much lower than that of realised inflation. As a consequence, the dispersion of real of the relevant measure of real interest rates is limited."