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back to index backEUROtalk April,  2005

Single monetary policy a bane?

The recent data on economic growth in the euro area has once again stoked concerns that the ECB's monetary policy geared to the EMU average is increasingly struggling to take account of realities on the ground.

Economic performance among the big member states did indeed vary in the final quarter of last year. Whereas both Germany and Italy saw output fall, the French and Spanish economies exhibited robust growth. But to conclude from this that these two countries, unlike Germany and Italy, urgently require a rise in key interest rates would miss the point.

In France, while it is true that economic growth last year was roughly twice as high as in Germany (working-day adjusted), and the increase in house prices is a cause for some concern, there has been no convincing rise in employment despite better growth – the jobless rate recently rose to the symbolic 10 % mark – and the rate of inflation dropped to 1.6 % in January. This does not indicate a serious risk of inflation or a need to raise interest rates.

It may be that a prompt tightening of monetary policy would be appropriate in the case of Spain, given the favorable performance of the labor market which has accompanied the economic growth. This is reinforced not only by a booming real estate market, but also by inflation rates substantially higher than the EMU average.

However, the issue that has been apparent since work on monetary union was first begun applies to Spain as well: The single monetary policy cannot take different rates of inflation and growth between the member states into account, let alone influence them. If the level of key interest rates seems inappropriate for an individual country, counter-measures need to be taken at the national level. Spain now has the leeway it needs to chart a more restrictive course in wage and fiscal policy, in order to create the proper policy mix with a monetary policy that, from a domestic point of view, appears overly relaxed. Absent this, higher inflation will sooner or later pour cold water on Spain's economy. This is the primary adjustment mechanism in a single currency area. Thus, key rates can remain low for some time at 2 %.

Source: Dresdner Bank - GAI

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