THE EUROPEAN Central Bank (ECB) has done few favours for some of the smaller euro zone economies in difficulty – such as Ireland – with its latest interest rate cut. The ECB lowered its benchmark rate to 1.5 per cent on Thursday, the lowest level since the bank took control of monetary policy a decade ago.
The 16-nation euro zone economy contracted sharply in the final quarter of 2008, as exports collapsed and unemployment rose. And ECB forecasts suggest economic performance will deteriorate further in 2009. The recession in the euro area is deepening and growth is likely to fall by up to 3 per cent this year.
Ireland’s difficulties, however, are far greater. Here, economic activity is expected to decline by 5 per cent. The unemployment rate, already more than 10 per cent, is certain to increase significantly this year. ECB president Jean-Claude Trichet said the bank had not ruled out a further interest rate cut, possibly in May. But the bank’s preoccupation with fighting inflation, a problem that no longer exists, has been a mistake. It has meant the ECB has acted too slowly in meeting the real challenge – deflation. The bank has underestimated the scale of the economic downturn and by doing so has slowed the pace of recovery. Euro zone interest rates have been too high for too long and this week’s cut was again too little and too late.
The ECB’s preference for a conservative policy on interest rates is in marked contrast to the aggressive approach adopted by other central banks. The Bank of England cut its benchmark rate to 0.5 per cent on Thursday, the lowest since the bank’s foundation in 1694. And the bank announced that it was preparing to print money to fight the recession, by buying financial assets to ease the credit crunch. Likewise, in the United States the Federal Reserve has cut interest rates to close to zero and has already used the printing presses – so-called quantitative easing – to boost, temporarily, the supply of money and credit.
Ireland must rely solely on monetary policy to stimulate economic activity here. A soaring budget deficit and the weakening state of the public finances rule out fiscal stimulus. As a euro zone member, Ireland – given its size – has limited influence over what the ECB decides. A deepening recession may yet force the ECB to change focus and switch direction, this time to fight the right war on the real enemy – deflation. And for the sake of the euro zone and Ireland, the sooner the better.