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Q&A

Dealing with the crisis on the Continent

Charles Goodhart, an expert on European monetary policy, discusses interest rate cuts and inflation.

October 11, 2008|Henry Chu | Times Staff Writer

Charles Goodhart is professor emeritus of banking and finance at the London School of Economics and an expert on European monetary policy. He spoke to The Times about Europe's handling of the economic crisis and the role of the European Central Bank, which joined Wednesday with central banks around the world in lowering interest rates. It was the ECB's first rate decrease in five years, from 4.25% to 3.75%, after keeping the rate elevated to ward off inflation.

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Should Wednesday's interest rate cut have been greater?

Interest rates are going to go on going down. And if one is so confident that interest rates are going to go down further, then why not do more now? There are a number of answers to that. One is that we still have inflation well over target. Another is if you get too far ahead of the market, you'll be accused of panicking. People will say, "Well, my God, if they had to cut 2%, it must be very dreadful out there." The third thing is if you're operating on your own, and you have a big current account deficit, you will find the exchange rate working against you.

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Would a bigger rate cut by the ECB or in Britain have been counterproductive?

If the U.K. had gone down 100 [basis points, or 1 percentage point] by itself, and everyone else was going down by 50, it would have suggested that the U.K. authorities thought the U.K. was in far worse position than everyone else, and it would have caused a sharp fall in sterling. . . . There has been a lot of criticism in Europe of the U.S. for having cut the rates so much faster, along the lines that it didn't do much good.

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Over the last few weeks, the ECB has repeatedly made more money available to European banks and has now cut the interest rate. Are these piecemeal and stopgap measures?

I think the ECB would rather take the opposite line. The ECB would argue that this has really been a crisis connected with liquidity, and what they have done is they have systematically made liquidity much more quickly and more reasonably available than the Bank of England, for example. Given the inflationary pressures in the world, it was right to keep interest rates up. They would criticize the [U.S. Federal Reserve] as not having done enough to expand liquidity and doing too much on interest rates.

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Couldn't you say that the ECB has been too focused on inflation?

One has the splendid advantage of hindsight. I think that you could certainly say that once one had reached the panic stages of the last two to three weeks, that you had to shift balance toward trying to prevent an economic depression and the likely deflation that might go with it. Again if you were asking Europeans and the ECB, they would say that the crucial step and indeed the crucial mistake was allowing Lehman Bros. to default, and that changed what had been a pervasive and difficult liquidity problem and generalized lack of confidence into an outright panic. It's a European view.

I think the American view is that the ECB are a group of old Germanic Prussians who focus solely on inflation targeting and can't see the world in front of their eyes, and the European view is that the Americans systematically took the wrong steps at the wrong time. They didn't provide enough liquidity and they panicked over interest rates and it didn't help them. No doubt the truth lies somewhere in between.

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One British columnist said that "inflation is yesterday's problem." Do you agree?

Inflation is not tomorrow's problem because of what has happened, but it's going very much to be the problem the week after tomorrow.

What I mean is that the recession is going to be sufficiently serious that the central banks around the world have got to lower interest rates, perhaps even lower than in 2001; they've got to flood the world with liquidity.

When the world recovers . . . there will be an absolute seabed of massive inflation. We've got to handle the crisis first and do whatever it takes to do that, but the resolution of the crisis is going to leave our economic systems absolutely at risk against future massive inflation.

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When it comes down to a crunch like this, do the central banks of individual European countries have more clout than the ECB?

No, as far as it comes to monetary policy. The problem here is that there is no ministry of finance or fiscal authority behind the ECB.

When it comes to financial stability issues, it often depends on having taxpayer money at hand, and there is no source of such money at the European level.

The only money available is at the national level, the nation-state's money.

What you've seen therefore with the attempts to bail the banks out is that it's all at the nation-state level. There hasn't been anything undertaken at the European level.

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We've heard many vague pledges in the last few days of European cooperation. Is further European cooperation actually possible?

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