October 24, 2011
The Guardian Unlimited, October 24, 2011
Jean Claude Trichet will be retiring as head of the European Central Bank at the end of the month. He will step into retirement having wreaked the sort of destruction on the European economy that hostile powers can only dream about. Tens of millions of people across the eurozone countries are unemployed or underemployed because of his mismanagement of Europe’s economy. Meanwhile the world teeters on the brink of another financial crisis because of the ECB’s failure, along with the IMF, to effectively address the sovereign debt crisis. Most incredible of all, Trichet probably thinks he has done a good job.
This last point really is central because the ECB, like much of the economics profession, continues to be controlled by a bizarre clique that believes that the most important, and possibly only, goal that a central bank should pursue is a 2 percent inflation target. By this measure, the ECB has done reasonably well, even the as the euzo zone economy has crumbled around it. After all, inflation in the eurozone economies rarely exceeded 3 percent and averaged well under the 2 percent target over the last decade.
However, the low and stable eurozone inflation rate is not going to provide much help to the 21.2 percent of the Spanish work force that is unemployed or the 14.6 percent of the Irish workforce, nor the millions more elsewhere in the eurozone who have lost their jobs as a result of the collapsed of the housing bubbles that the ECB let grow unchecked.
If Trichet and his colleagues at the ECB had been awake, they would have noticed that real house prices in Spain had more than doubled between 1998 and 2006. The same was true in Ireland. There was no remotely comparable increase in rents, strongly indicating that this run-up was not being driven by the fundamentals of the housing market.
And in both countries, the massive run-up in house prices was having the predictable effect on the economy. Both countries had huge building booms and surging consumption, as homeowners spent based on their bubble-generated housing wealth. In both cases, this led to extraordinary balance of trade deficits that were clearly unsustainable for advanced economies.
How could Trichet and his colleagues have failed to have noticed these housing bubble and the economic distortions that they were creating? Or, insofar as they did notice them, did they have a theory whereby economies can seamlessly replace the 10 percentage points of GDP worth of demand, or thereabout, that was being generated by the housing bubbles in these countries?
It didn’t help that much of the rest of the eurozone also had bubbles in their housing markets (Germany was the big exception); although they were not creating quite as large distortions as in Spain and Ireland. Nor did it help matters that important non-eurozone countries, like the United States and the United Kingdom, also had bubbles in their housing market and that the whole process was being driven by over-leveraged banks.
It is very difficult to see how a central banker in the eurozone could have looked at the economic situation in 2004, 2005, or 2006 and not be concerned about the impending disaster that eventually overtook these economies. The warning signs were all over the place and flashing bright red everywhere, but rather than taking the regulatory and monetary actions necessary to deflate these bubbles – including giving clear and persistent warnings – Trichet and his colleagues focused on their 2 percent inflation target.
Remarkably, even after the collapse of the bubbles, with the eurozone economies smoldering in the wreckage, the ECB continues to be obsessed with its 2 percent inflation target. While the Federal Reserve Board lowered its overnight money rate to zero and has had several rounds of quantitative easing to try to reduce longer terms rates, the ECB never lowered its short-term rate below 1.0 percent. It actually raised it to 1.5 percent last spring in order to stem inflationary risks.
More recently, along with its troika partners the European Commission and the IMF, the ECB has had the whole euro zone financial system, and indeed the world financial system, teetering on the brink of disaster as it tries to squeeze additional concessions out of Greece and other debt-burdened economies. While the betting is that a resolution to the debt crisis will be reached before the whole system explodes, the ECB and its partners are imposing enormous risks on everyone else for concessions that are of questionable value, at best.
It would be tragic if Mr. Trichet is allowed to go into retirement thinking that he has done a good job. In terms of public service, Trichet’s performance ranks a notch or two below Michael Brown watching New Orleans drown when he was head of the Federal Emergency Management Agency.
Humiliating Trichet is not just a question of justice or morality; although is painful to see someone who caused so much harm escape with impunity. More importantly, it is an issue of incentives. The people given responsibility for economic policy should be held accountable for their performance. If Trichet is toasted into retirement, we have no reason to expect any better performance from his successor. That would be a real disaster.