The idea in the end, of course, is to create a full internal market without variances between national economies. We are indeed a long journey away from that situation, and there are many hurdles to take: fiscal policies and legal frameworks being among the most important.
“Britain is not yapping about the concept of an idependent bank- we are yapping about the concept of a national bank linked to national needs, i.e. not a “one-size-fits-all” policy that cannot take account of variances between national economies (or indeed be influenced by the voters of countries which do badly out of it).”
Underlining mine.
As stated abovee, you are 100% correct on the first part of your sentence, but the underlined part seems to indicate that you would feel comfortable with a central bank (federal or national) that can be influenced by politicians, and indirectly, the voting public. Surely, you can see the importance of a fully independant central bank, regardless of the context it is in?
Granted that America is not Europe, or vice versa, some of the issues I see raised here are ones the US has been dealing with for some time.
While the US has some of the richest folks in the world, and while on average we do very well, we also have pockets of dire poverty (something that, perhaps, does not always make the news abroad). And this does vary region by region, as does the rate of house ownership vs. renting, employment, the health of various industries, and so forth. Raising (or lowering) interest rates will benefit some, harm others. We have some states that would be major countries in their own right with booming economies, and others that, if not part of the United States, would be considered third world countries with a low standard of education and living.
Our system, which may or may not be suitable to European concerns, has some control on the state level, some on the Federal. While Europe has long had controls on the (sovereign) state level you have just adopted your first continent-wide currency. There are going to be at least a few problems and glitches. Maybe it’s been forgotten, but in the early years the USA teetered on the edge of bankruptcy for decades, at least once Alexander Hamilton bailed out the Feds with his own money, and there were all sorts of squabbles over the same issues Europe is dealing with now. And we only had 13 parties to start with.
I think making a continent-wide “internal market” will be of benefit to all Europe in the long run. Short term, there will be some pain and upsets. Actually, eveything seems to have gone pretty smoothly so far, but since I’m over here that’s just an impression, I don’t know if it’s fact or not.
Independence is good, for sure - what I meant by the second part of the sentence is that your national economies are no longer run according to national interests, which must be bad for some unless they are all in step. And until they are in step, the voters in the countries that do badly can do bugger all about it.
Rushed phrasing, I know - but I have to get to the pub… Footy is starting!
(somewhere in another thread someone asked how we hadn’t chewed our arms off in the last 15 minutes on Friday. All I can say is that I’m typing this - slowly - with my toes).
Ok, let’s carry on before the Nigeria game on Wednesday.
Coldfire; I defer to the fact that YAAE -
I’m interested; which bits do you think I’ve got wrong? (or, which bits am I over/underestimating)?
Ah, no worries Xerxes, you got the gist of it just fine, and that’s more than most people can say.
… which would mean foreign investors could gain a better return on their investments in the South, rather than the North. As a result, the economy in the South blossoms even more.
Your reasoning is probably: if we lower the interest rates locally, it will be cheaper to invest, because a company can aquire cheaper financing. This doesn’t take international mechanisms into account, however. And for the sake of the argument: having two interest rates (and thus, two currencies) would make your example “international” per economic definition. Whether you want it or not.
There’s more than a grain of truth to your reasoning here, sure. But it’s a simplification, and as we all know, they often fail at a more detailed level. Were I to extend your logic, lowering the interest rate would make an economy grow indefinitely. We all know this isn’t true, as a negative growth means deflation: the sign of a stagnant economy gone bad.
There is one important thing to realise: an interest rate and its currency’s exchange rate are linked.
Consider this example.
We shall pretend the world knows two economies: the UK economy, and the US economy.
Initially, both UK and US interest rates are 6%. The GBP/USD exchange rate is exactly one.
The UK decides to raise the interest rate from 6% to 8%. Due to the mechanisms of foreign exchange, the GBP appreciates against the US Dollar: the reason is, that for a US investor, putting his money in a GBP deposit would give him 8% whereas a domestic deposit only gives him 6%. Since foreign exchange is a zero sum game, the exchange rate will counter this effect, rendering it zero. In this case, the exchange rate will become 1.06/1.08 = .98 GBP/USD.
I hope that example makes sense - I never aspired to be a teacher, see.
Anyways. You stated that increasing the interest rate “puts the brakes” on an economy. First off, this depends on a lot of things. The effect you describe it true: if the central bank increases the interest rate from 6% to 8%, and commercial banks will maintain their 2% mark-up, then a company will suddenly have to pay a lot more for a loan, and they might postpone investments, leading to less productivity. Sure.
But that’s not the only thing. Let’s look at your next piece of text to see where it goes wrong:
Exactly!
But! The process works the other way 'round, too. If an economy grows too slowly, a central bank might increase the interest rate in order to appreciate its currency - but generally, they will do this only if they have a trade deficit. Importing goods becomes easier (this is helpful for small economies with little resources), whereas the lost export will only even the balance.
Now, onto inflation. You don’t “set” inflation. In fact, an independant central bank has little influence on it at all. You may counter inflation by playing with your interest rate, but you don’t set it. For a good, easy to understand description of the mechanics of inflation, see this excerpt from “Economics for Dummies”. No offense.
Also, it is important to note -as in the linked article- that inflation actually favours those already in debt. So, in your example, outstanding loans and credit card debt may become more “expensive” nominally to maintain, but if the increased interest rate is the result of inflation, you may actually end up paying back less, depending on whatever mark-up your central bank applied.
God, I hope I have now sufficiently demonstrated why I’m not an Economics teacher. Whew!
None taken. I took Economics at A-level but have gone down a different path since then. Thanks very much for the link - it explained quite a lot and reminded me of a whole lot of phrases (demand-pull vs. cost push, the multiplier etc).
Sorry, I was imprecise here; what I meant to say for ‘setting inflation’ was ‘setting a maximum inflation rate target’. I admit my ignorance here - is the ECB tied to pursuing a pan-european inflation rate target as the MPC is for the UK?
Not exactly, at least not yet: the still diverging fiscal policies, for example, make this impossible. Yeah, they’d LOVE a pan-Euro inflation rate, but under the current circumstances, it’s not possible. It’s a bit of a first: it will be a single market one day (right…?), but for now, all it is is a bunch or rather diverse economies bound by a common currency. A scenario that’s bound to benifit some, and hurt others - but that’s the way it is.
In the UK, the inflation target is set by the government. Across Europe, this is not possible as the national economies are so different. So, at the moment, the ECB aims for a pan-European “price stability”, which it does by setting its own inflation target.
The crucial difference is that the MPC in the UK aims for inflation range (i.e. i% ±x, or a symmetrical target), whilst the ECB has an upper inflation limit (i.e. <i%, or an assymetrical target).
[Oversimplification] As a result, in the UK, the central bank must pay just as much attention to a situation where inflation is too low - which could mean the UK is heading for an a recession - as when inflation is too high. The ECB, on the other hand, only needs to take action when inflation is getting too high (as it is modelled on the German Bundesbank, which was traditionally worried about high inflation) - which can make it slow to respond to a recession. [/Oversimplification]
