The European Central Bank (ECB) has lost its nerve and risks halting the euro zone's nascent recovery, according to Mr Alan Blinder, the man tipped to take over as chairman of the US Federal Reserve.
Mr Blinder, who was in Dublin to address an NCB Stockbrokers meeting yesterday, also dismisses fears about a crash on Wall Street.
The principal reason the ECB raised rates last week, he maintains, was its discomfort with the prevailing level of 2.5 per cent given that the average euro-zone inflation figure - running at 1 per cent - means that the so-called "real" interest rate was 1.5 per cent. This is below what economists see as neutral or normal.
This contrasts with the approach of the Federal Reserve - the US Central Bank of which he is a former vice-chairman - where in an economy of comparable strength to the euro zone now, real overnight interest rates were held to zero for a year and a half. Between 1992 and the beginning of 1994 the Fed held interest rates at 3 per cent when the inflation rate was also 3 per cent.
Mr Blinder told The Irish Times: "That is really stepping on the accelerator. The ECB plainly did not have the nerve [to do likewise] because that takes some nerve."
By 1994 the economy was roaring along, he recalls, and Mr Greenspan moved the rate "back up to neutral".
The central issue, according to Mr Blinder, is the preparedness to take a risk for growth. The ECB, of course, under the Maastricht Treaty is obliged to put inflation first, unlike the Fed which has a joint mandate of employment and prices.
But even taking account of the legal differences, Mr Blinder said he would question whether, when current macro economic perspectives are considered, there is any danger of inflation overshooting 2 per cent.
He added that all the main euro-zone economies of Germany, France and Italy should be capable of growth of some 4 per cent to 5 per cent a year for several years, putting the current estimates of 2.5 per cent into the shade.
Co-director and founder of Princeton's Centre of Economic Policy Studies and former adviser to President Clinton, Mr Blinder also insists that he does not put much store in the theory that a crash on Wall Street may be imminent. However, he said a sudden 10 per cent fall would not do much damage in the US - "except that it could have a bigger knock on impact in Europe or Japan".
He is less sure, however, about the outlook for Internet companies, the valuations of some of which he describes as "fabulously over-rated". And even among the more ordinary technology stocks such as Cisco, Microsoft and Intel, which are very sound companies, he says it is "plausible that there is a substantially bigger bubble".
It is a sign of how seriously central bankers are now taking equity markets that the Fed is now playing very close attention to it. Values on Wall Street are used as an indicator or precursor to consumer spending, according to Mr Blinder. Over the last number of years consumer spending has been growing faster than income growth and most of the difference has been made up by the stock market.
"The Fed is watching it closely and would love to see it lower," he added. However, stating that one level more than another is appropriate is simply not possible, he pointed out.
Many are expecting the Fed to raise interest rates again at its meeting next week. But according to Mr Blinder there is no reason why it should do so. "Unemployment is less than 5 per cent and almost reaching 4 per cent while core inflation, excluding energy prices, is falling. At the same time wage pressures are amazingly moderate given the tightness of the labour markets." This gives the Fed every reason to hold rates and go for higher growth, Mr Blinder said.
Asked whether he would raise rates if still at the Fed, he said he would be "disinclined to".
Mr Blinder was also fairly dismissive of worries about the enormous US current account deficit and points out that fears in this regard are more pronounced in Europe than in the US. "The idea that capital would stop flowing into the US as if it were Korea just does not figure," he said.
However, he did add that at some point there will need to be a combination of higher interest rates and a lower exchange rate. "And my suspicion is that it would be mostly on the exchange rate."
"To modulate the current account deficit will require a very significant fall in the dollar. That gives you no information what the dollar will do in six months or so. But over five to 10 years it could be far lower."
It is still not clear when, or perhaps if, Mr Blinder will take over from the almost mystical Mr Greenspan. But he insists it will not be in 2000. The former vice-chairman of the Fed says there is no doubt but that Mr Greenspan will be appointed again next year, whoever is president. That will be a relief to financial markets who are likely to react very negatively to any news of Mr Greenspan's departure.
