麻豆社

Trichet: Beware the oil shock

• Robert Peston
• 19 May 08, 05:00 AM

What if the Bank of England were not to bear down on inflation in the face of the upward pressure from rising global energy and food prices?

What if it were to respond to popular, corporate and political calls for cuts in interest rates, to give some oomph to an economy slowed down by the credit crunch?

In a worldwide trawl of bankers and economists - which I made in preparing a documentary to be broadcast at 8pm tonight on Radio 4 ("Power Failure at the Central Bank") - a compelling case for not cutting interest rates came from across the Channel, from the veteran public official who is arguably the most respected central banker in the world right now, .

What he said, with passion and conviction, is that the price of failing to set interest rates at a level that keeps inflation in check would be the rise of mass unemployment that would hurt us for at least a generation.

Or to be more precise, he argued that the current rise in energy and food prices is comparable to the oil-price shock of the early 1970s. And he insisted that the failure of most European economies back then to suffer the short term pain of tighter monetary policy, higher interest rates, led to inflationary wage settlements that undermined economic competitiveness.

"Before 1973 and 1974, there was everywhere in Europe full employment," he told me. "It is after the absence of sufficient lucidity in analysing what was happening after the first oil shock, trying to protect ourselves from the first oil shock and not understanding that we had a real transfer of resources associated with the first oil shock, all that created mass unemployment.

"And we are still fighting against unemployment which is at a level that is not satisfactory in the euro area and which is the legacy of these mistakes in the first oil shock."

Or to put it another way: cut rates and risk long-term, serious damage to all our prosperity.

The commodity-price surge has pushed the rate of in the eurozone well above the formal target of less-than-but-close-to 2%. But high inflation "will not last forever", he said, adding ominously that "we are there to care for it going down."

He argues that even if the sharp rises in energy and food prices represent a one-off realignment, they can't be seen as somehow irrelevant to an assessment of the core rate of inflation, or as immaterial to where interest rates should be set.

What Trichet fears is what he calls "second-round effects", such as wages being set at levels that assume inflation will not fall - which could precipitate endemic inflation, a debilitating virus that would be hard to shake off.

Chatting to Trichet was in some ways strikingly similar to listening to Mervyn King, the Governor of the Bank of England, as he warned last week (yet again) that his fabled NICE era of non-inflationary consistent expansion is well and truly over. As it happens, Trichet has a strong empathetic relationship with the Bank. He said:

"I feel very close myself to the Bank of England. I feel that the Monetary Policy Committee of the Bank of England and the Governing Council of the ECB have very much equivalent analysis on this major point... that we had to have a monetary policy stance which would be designed to deliver price stability."

Or to put it another way: there's not the faintest chance of interest rates falling in the eurozone or the UK for some time (if at all).

The other very striking point made by Trichet is that he rejects any suggestion that the ECB should have an explicit goal of (in his words) "ensuring stability in the price of assets". He said: "it doesn't seem to me possible."

He added: "We will do all we can to delivery price stability and ensure financial stability through the delivery of price stability. But we cannot directly target asset prices. That would probably be something which is impossible, I would say, and not advisable at all."

This matters, because one of the causes of the credit crunch was the rapid and unsustainable rise in asset prices, especially property prices, in the preceding two or three years.

During those bubble years, Trichet was at the forefront of central bankers warning about the dangers of all those trillions of dollars being lent and invested without due regard to the proper risks. He spotted that asset prices were inflating too fast.

But his sounding of the alarm did nothing to stop the bubble expanding to near lethal proportions - such that when it popped, the cost for the financial system and the global economy was very substantial.

Perhaps sensibly - chairman of the - is reviewing (against his own revealed instincts) whether his central bank should intervene more conspicuously when asset prices surge.

M.Trichet implies Mr Bernanke is wasting his time.

Probably better, as many central bankers and regulators now believe, would be to look at whether new rules can be introduced that would raise and lower the capital requirements of relevant financial institutions in a counter-cyclical way - such that their capacity to lend too much too cheaply was constrained in boom years (with the corset being loosened in downturns).

So are we, at the least, over the worst of the credit crunch? The Bank of England recently said there were signs that financial markets are past their nadir.

What is the prognostication of the wily M Trichet, who has had a ringside seat at every international financial crisis since the mid-1980s? Well I pressed him and pressed him, and he pointedly refused to say that the point of maximum danger is behind us.

All he would say is that we are experiencing an "ongoing, very significant market correction."

Which, given his record of calling the credit crunch rather more astutely than the Fed or the Bank of England, isn't conspicuously reassuring.

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