Benn Steil


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Draghi’s Dilemma

by Benn Steil and Dinah Walker
April 26, 2013


The Governing Council of the European Central Bank meets on May 2, with a possible rate cut in the offing. Yet a rate cut is not the no-brainer the Bank’s critics often suggest, as today’s Geo-Graphic shows.

The ECB’s official inflation-rate target is “below, but close to, 2%.” Both Portugal and Greece have inflation under 1% , but the transmission mechanism from ECB rates to business borrowing rates in those two countries has been virtually severed by the crisis. In short, they need a rate cut, but the ECB can’t deliver them one.

In those Eurozone countries where the monetary transmission mechanism is still working normally—Austria, Finland, France, Germany, and the Netherlands—the GDP-weighted-average inflation rate is 1.8%, right near the ECB’s target. France, with 1.1% inflation and 10.8% unemployment, would appear a strong candidate for a rate cut, but not the others. Germany has 1.8% inflation and only 5.4% unemployment. The other three all have above-target inflation rates: Austria at 2.4%, Finland 2.5%, and the Netherlands 3.2%. Austrian unemployment is low, at 4.8%. Dutch unemployment is a moderate 6.4% Only Finnish unemployment is high, at 8.2%.

Some will argue that a bout of robust inflation in the north is just what is needed to restore competitiveness in the south. But the ECB will have to willfully ignore its price-stability mandate if it is to justify a rate cut right now, and it will almost certainly need to apply more radical tools if it is to aid the south quickly. “The ECB is obviously in a difficult position,” German Chancellor Angela Merkel said on April 25. “For Germany, it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing.”

Yes indeed. This is Draghi’s Dilemma.

Geo-Graphics: Is the ECB Draining Its Own Powers?
Financial Times: Merkel Speech Highlights European Divide
Reuters: Merkel Says Germany Would Need Rate Rise
Wall Street Journal: Bleak Europe Data May Prompt ECB Action

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