For the ECB to be more effective it needs to follow the lead of the Federal Reserve
Opinion: US body has duty to regard level of unemployment, not just inflation
President Barack Obama with Janet Yellen at the White House in Washington last week. Photograph: The New York Times
In her speech accepting the chairmanship of the US Federal Reserve, Janet Yellen stated that her main priority would be implementing monetary policy in a way that minimised unemployment. She also said she was aware of the economic and social strains caused by unemployment, something we have not heard from the current president of the European Central Bank, Mario Draghi.
Her concern is not surprising in view of the fact that much of her highly respected research has been on unemployment and its effects. Because she is known to give priority to reducing unemployment over maintaining a very low rate of inflation, she is known as a “dove” to the Wall Street vultures who respect only “hawks”, such as the former chairman Alan Greenspan, who consistently favoured reducing inflation over reducing unemployment.
If Janet Yellen had been made president of the ECB, she would not have mentioned unemployment in her speech, because the sole objective of the ECB is the control of inflation, while the Federal Reserve has as its mandate not only the control of inflation but ensuring that unemployment is minimised. If inflation rises above 3 per cent in the euro zone, the ECB must immediately take steps to reduce it.
When the euro was introduced and the ECB established, Germany’s Bundesbank insisted that maintaining low inflation be the overriding objective. It is significant that the ECB is located in Frankfurt, down the street from the Bundesbank.
The Bundesbank’s prioritising of inflation control was an understandable result of Germany’s experience of hyper-
inflation in the late 1920s and again at the end of the second World War. While some historians argue that hyperinflation in the late 1920s contributed to the rise of Hitler, it could also be argued that it was the mass unemployment that resulted from Chancellor Brüning’s drastically deflationary policies in 1930 that led to the surge in support for the Nazis.
Another factor that determined the anti-inflationary stance of the ECB was
the collapse of the “Keynesian consensus” that governments could ensure full employment by managing aggregate demand through state spending and taxation. The combination of low growth and high inflation of the 1980s, which Keynesian policies could not solve, led to the rise of new classical macroeconomics, which argued that people were capable of anticipating changes in macroeconomic policy and reacting to them.
If this is true, were a central bank to increase money supply in order to stimulate the economy, people would anticipate inflation and seek pay increases to compensate for that inflation, which in turn would reduce employment. The increase in the money supply would be self-defeating.
According to the tenets of new classical macroeconomics, rational expectations and efficient markets would render stabilisation policy ineffective. From the late 1980s until the economic crisis of 2008, inflation did indeed fall and the period was referred to as “the Great Moderation”. But while inflation was low, growth was lower in most rich countries than it had been in the 1970s and though unemployment fell, job security decreased and work intensified in many occupations. The number of banking crises was also higher in the 1990s than in the inflation-ridden 1970s and early 1980s.