Macroeconomics

22 July 2014

Europe's Monetary Conundrum 

Monetary authorities are called on to keep prices stable, promote economic growth and curb asset bubbles – yet doing all three simultaneously is proving exceedingly difficult.

The latest evidence is German Finance Minister Wolfgang Schäuble’s recent proposal that the European Central Bank (ECB) pay more attention to asset price distortions caused by loose monetary policy. While Germany wants more fiscal discipline, EU partner France would prefer monetary easing to drive the euro lower and make its exports more competitive overseas.

Europe’s two largest economies face differing realities. Germany’s is growing fast enough for its government to be alert to signs of rising consumer price inflation. But in France, slow growth raises the specter of deflation and makes it harder for the government to reduce its budget deficit in line with ECB targets.

Pointing to signs of inflated real estate prices, Schäuble says central bankers should not leave action on asset price bubbles to country officials. Analysts have noted that monetary stimulus in the U.S. has helped push stock prices to all-time highs. Rapidly rising housing prices in the U.K. have also raised concerns that mortgage rates are too low.

Having confronted two major asset-price bubbles in the past 15 years, authorities – and investors –are more sensitive to the dangers than in the past. But while preventing asset bubbles is a noble aim, in practice it can be extremely difficult to tell the difference between the product of strong growth and markets overheating.

Monetary authorities cannot lose sight of their twin responsibilities of keeping inflation at the right level and fostering healthy growth. But given the lessons of the past decade and a half, they cannot afford to ignore the risks of irrational exuberance, either.