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Analysis

The ECB has got it exactly right on the euro

Trump, German hawks should show gratitude to Draghi

by Waltraud Schelkle in London

Thu 16 Feb 2017

The Donald Trump administration has criticised Germany for allegedly supporting a dollar-euro exchange rate that allows Berlin to ‘exploit’ the US and run a large trade surplus. Ironically, the German government seems to agree with this allegation by Peter Navarro, the new president’s chief trade negotiator. Wolfgang Schäuble, German finance minister, and Jens Weidmann, Bundesbank president, have again complained about a monetary policy that is too loose for German price stability.

If a novice trade negotiator and German hawks agree that the European Central Bank’s policy is too lax and hence the euro too weak, surely ECB President Mario Draghi and his board of central bankers must be doing something right. Not entirely, says David Marsh in a recent OMFIF commentary: ‘In one aspect of currency market invective, the Americans have a point, in indicating that economic and monetary union in Europe distorts interest rates and exchange rates through ‘one size fits all’ monetary policies. Interest rates were undoubtedly too high for Germany during the first few years of EMU after it started in 1999. And they are too low for the Germans at the moment.’

It is not clear to me why current interest rates are too low for Germany. The German current account surplus of 9% means that the price level and domestic demand are too low for more balanced trade. So the ECB’s quantitative easing, in addition to independent capital flows, will stimulate domestic demand and make it more profitable for German firms to sell at home and to raise rents, wages and prices. This is the right policy for rebalancing the German economy, given the reluctance for domestic fiscal expansion.

If such measures stimulate the German economy, tax revenues will rise and Schäuble may even achieve his goal of fiscal consolidation by simply sitting back and enjoying the benefits of the Goldilocks economy. But he seems to think that criticising the ECB goes down well with voters who may otherwise be attracted to the right-wing and eurosceptic Alternative for Germany. Taking this line of ‘I feel your pain, trust me’ is what David Cameron, former British prime minister, tried to do in the run-up to the UK’s referendum on leaving the European Union. Cameron kept on criticising the EU, but still recommended remaining a member of the bloc. To his great surprise, a majority of the those who voted in the referendum followed his criticism and preferred to end the (phantom) pain caused by the EU.

If the Trump administration had any understanding of macroeconomics, it would show gratitude to the ECB instead of portraying it as a kind of German Reichsbank. Real exchange rate appreciation in Germany will contain US surpluses, if the national stimulus there does not trump the price effect. But it seems such expertise is too much to ask from the new US administration, which would rather attack institutions than think through its economic analysis. Seasoned commentators should not concede anything to the bullies in the White House.

Waltraud Schelkle is Associate Professor of Political Economy at the London School of Economics and Political Science.

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