Trichet signals higher interest rate for the EU

Melvyn Krauss, Project Syndicate

The announcement by the President of the European Central Bank, Jean-Claude Trichet, that interest rates would be raised at the next meeting of the bank's Governing Council on Dec. 1, could be a defining moment in his presidency.

By pre-announcing the rate increase, which senior ECB officials call a move towards greater transparency, Trichet firmly demonstrated his leadership of the Governing Council. Press leaks by dissident members had sowed confusion in the public's mind as to the bank's concerns and intentions before the announcement.

Even though a consensus had emerged in the Council that a December interest rate hike would be necessary, a handful of holdouts on the ECB Governing Council -- some with their own very private agendas -- leaked misleading and, in one instance, clearly false information to the press in a futile attempt to thwart the increase.

In an anonymous leak to a major financial news service, an ECB official falsely maintained that unanimity was needed for a rate hike, implying a single dove could stop it. Infuriated by what he considered to be guerrilla tactics, Trichet effectively silenced the mischief-makers by the bold stroke of pre-announcing the rate hike two weeks before the meeting.

This is not the first time communications has been a problem for the ECB. On more than one occasion, under both Trichet and former ECB chairman Wim Duisenberg before him, press leaks and the tit-for-tat responses they engender, made the Governing Council sound more like a cacophony of discordant voices than a serious deliberative body.

Now, to his credit, Trichet has done something about this long-standing problem, although not without ruffling some feathers in the process. The doves are furious about the pre- announcement, and some hawks -- perhaps nostalgic for the more collegial style of Wim Duisenberg -- regard Trichet's move as "showing off" and "taking control." Indeed, a leading Dutch financial newspaper attacked the pre-announcement as a sign of Trichet's weakness rather than strength, implying that he had lost control of the Governing Council.

This is unfair. The recalcitrance of the holdouts against the consensus -- a direct challenge to Trichet's leadership -- gave the ECB president little alternative. What was he to do? Let the holdouts undermine his personal credibility and that of the bank?

The unwillingness of frustrated minorities to accept consensus may well require the ECB president to take more control of the governing board than it has been used to in the past or, indeed, feel comfortable with in the future. More than anything, the pre- announcement controversy demonstrates that a renewed spirit of consensus and collegiality in the ECB's Governing Council is sorely needed.

Because Trichet's pre-announcement of a moderate interest rate hike conjures up visions of a Fed-like series of small interest rate hikes over an extended period of time, the ECB president also pre-announced his disinclination to follow in US Fed Chairman Alan Greenspan's footsteps in this regard. Indeed, a case even can be made that with the new leadership at the Federal Reserve expected to embrace European-style "inflation targeting," we may be entering a period in which the Fed follows the ECB on critical monetary matters rather than the other way round.

"Inflation targeting" means that a central bank puts the pursuit of price stability above all other objectives. This is what the ECB does -- and what the Fed's Alan Greenspan does not do. "Inflation targeting" also means the central bank follows certain specified rules. This too is what the ECB does and Greenspan doesn't do.

Ironically, the "inflation targeting" advocated by Greenspan's nominated successor, Ben Bernanke, lies closer to ECB monetary policy than to the discretionary activism that the Fed has practiced during Greenspan's long tenure.

Melvyn Krauss is a senior fellow at the Hoover Institution, Stanford University.