Thursday, March 6, 2008

The Federal Reserve And European Central Bank: A Difference Of Opinion

The Federal Reserve and European Central Bank have a very different opinion when it comes to managing economic policy. This is especially apparent when one looks at how their respective currencies, the dollar and the euro, have performed against one another. It seems that every day, the euro is setting a new high against the dollar. There is a great article in The New York Times that talks about this very issue, but I will attempt to summarize it here. Let’s take a look now at how the two central banks ideologies compare.

The Federal Reserve’s number one priority is economic growth. Their thought is that if growth stalls, then so will demand and inflation. To the Fed inflation is simply a byproduct of growth, so they aren’t too concerned with controlling it directly. They would rather control growth, and thus indirectly control inflation.

The European Central Bank focuses on growth as well, but they are also very concerned with inflation. They do not necessarily agree with the idea that inflation can be controlled (at least to their satisfaction) solely by focusing on growth.

Growth has been slowing both in the U.S. and in the European Union, but the central banks have had very different responses. The Fed has responded with a series of rate cuts, and will likely make even more of them, while the European Central Bank has left their key interest rates in place. In the U.S., the drastic rate cuts haven’t had much effect in ramping up the economy, and growth has come to a halt. In addition, inflation has been increasing dramatically, inspiring some to proclaim that the U.S. is entering into a period of stagflation. Growth in the European Union has continued to slow and inflation is above target at around 3 percent, but on both counts they are doing a little better than the U.S.

It is extremely hard to compare economic policies in this way because the two subject economies are very different. It will be interesting though to see how the two differing policies turn out in their results. I’m not a big fan of how Bernanke runs things, and I’m leaning towards the European Central Bank working out better, but we will just have to wait and see.

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