Thursday, November 24, 2005

Too Little, Too Late

During the latest week, ECB chief Jean-Claude Trichet have clearly indicated that interest rates will at last be raised to counter the increasing inflationary tendencies. As was to be expected, the politicians and pundits which previously argued for a rate cut are horrified by this. However, most likely the hike will only be a quarter point, to 2.25%. That means that it will still be lower than the 2.5% it was before the June 2003 rate cut and it means that interest rates will still be negative in real terms.

Given how extremely loose today's 2% is, with real rates being negative and money supply growth at 8.5%, a quarter point hike will clearly be too little too late to rein in the inflationary excesses consisting of not only too high consumer price inflation, but more importantly the housing bubbles created in most European countries and the increase in debt levels that have followed.

The politicans that now object to the small rate hike argue that growth isn't strong enough. Yet the fact is that today's 1.5-2% is aroung the 10-year average, so this weakness is not cyclical. Instead it is related to the excessive tax and regulatory burden as well as the aging population. If the politicians wants higher growth, they should do something about these structural problems, not aggravate the current inflationary excesses which might boost growth in the short-term but is likely to damage the economy in the long term (Not that we should expect politicians to consider the long term).


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