I think the ECB made a bad decision last week in keeping its interest rate unchanged. European interest-rate policy is an issue that Americans need to take more seriously; it is having and will have an increasing impact on the global flow of funds, on the value of U.S. stocks and bonds and, ultimately, on how well we all live. It was the day after the U.S. Federal Reserve had surprised markets by cutting its target for the federal-funds rate by half a percentage point, rather than the anticipated quarter-point cut. The ECB was holding its scheduled meeting. It was a great opportunity to join the Fed in cutting rates. Instead, as it has done for the better part of a year, it defied critics' calls for a rate cut. It left its overnight lending rate unchanged at 3.25%, compared with the Fed's 1.25%.
And the ECB held pat for reasons I find unconvincing. With its two largest economies -- France and Germany -- now stalling, the ECB held firm to its dogmatic policy that its raison d'etre is fighting inflation, not promoting growth. (The U.S. Fed, by contrast, has a dual mandate to promote price stability and growth.)
And how much inflation was it worried about? October inflation in the dozen countries that make up the Euro area was 2.2%, against its target of 2%. (And there's reason to believe that European inflation, which uses less sophisticated measurement techniques than the U.S., overstates the problem.)
It just so happens that in his testimony before Congress on Wednesday, Federal Reserve Chairman Alan Greenspan spoke to the very question of the different mandates of the ECB and the Fed: "It is not self-evident which of the two regimes are the most appropriate. I do think we are going to learn whether in fact their particular approach or ours is the more appropriate."
And then maybe, just maybe, he took a little jab at his counterparts across the Atlantic: "There are arguments on both sides," he said. "We obviously believe our arguments.")
The problems when there is a disparity in interest rates between two trading entities are that it affects the relative exchange rates, capital flows, and trade balances, etc. If the European interest rates are higher than the US, investors will get higher returns for relatively the same risk levels. This would cause capital to flow to Euro-bonds and other investments. This will raise the value of ...
The problems when there is a disparity in interest rates between two trading entities are examined.