Tuesday, November 28, 2006

High Money Supply Growth Shows Continued Need For ECB Hikes

There have been a number of voices recently calling for a pause in ECB rate hikes. This includes Bloomberg News columnist Matthew Lynn, Times columnist Anatole Kaletsky, not to mention of course European politicians.

Their argument is risks slowing next year due to a downturn in the U.S. economy, the lagged effect of ECB tightening, a rising euro and tax hikes in Germany and Italy. Well, they're probably right that the European economy will slow, primarily due to the tax hikes. Yet what is relevant here is the effect that ECB policy have. Trying to meet negative supply-side shocks with an "easy" monetary policy will only result in excess inflation. And so far we have yet to see much of a lagged effect of the ECB hikes. Money supply growth continued to be high, at 8.5% in October.

And while the strong euro and falling oil prices should contain consumer price inflation, it too will be pushed up by the tax increases. And by the boom in other commodity prices and the tighter labor market. The ECB should not damage the European economy with more inflation just because German and Italian politicians foolishly tries to reduce their budget deficits with tax increases rather than spending cuts.


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