Webpages useful for teachers of intermediate macroeconomics:

The European Central Bank and Its Monetary Policy


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In the aftermath of the terror attack on the World Trade Center on September 11, 2001, how should the monetary policy of the European Central Bank [ECB] change? Its immediate reaction to the terror attack was to cut interest rates by half an annual percentage point--50 basis points. But while the U.S. Federal Reserve continued to cut interest rates in the following weeks, the ECB held the reins short. At its policy meeting on October 11th, the bank held its refinancing rate unchanged at 3.75%, leading the Economist to worry that it "prefers to fight inflation rather than promote growth" and guess that "given the darkening economic outlook a further cut would surely have been wise." Since then interest rates have been cut by 50 basis points: the ECB seems to be moving at about half the speed of the Federal Reserve.

The direct impact of the terror attacks on America on the European economies will be minimal. The indirect effect channeled through America's recession on the European economies will be modest. Only one -fortieth of Europe's production is exported to America. The more important--and the most unpredictable--factor is the effect of the September 11 terror attack and its sequels on the confidence of European consumers, and on the willingness of European businesses to keep investing. The terror attack has greatly increased uncertainty, and the first rule of business prudence when confronted with uncertainty is to delay large and irreversible decisions until the situation becomes clearer.

Falling Consumer Confidence in Europe and America

Source: Economist.

The available indices of sentiment and plans all suggest that Europe is already in or about to enter a recession. Consumer and business confidence in Europe have both slumped this year. Already in August more European purchasing managers were reporting that they were cutting back than that they were expanding.

The ECB's decision-making problem is complicated by the fact that it receives data about the European economy one to two months later than the Federal Reserve receives data on the U.S. economy. If the Federal Reserve's data analysis and decision making lags mean that it is often behind the curve, things are worse with the ECB.

Previous Handouts

2001-11-12: Central Banks Worldwide Cut Interest Rates Again (Chapter 13: Stabilization Policy)
2001-11-05: Effects of the Collapse in Spending on Durables (Chapter 9: Income-Expenditure and the Multiplier.)
2001-10-28: What Kind of Stimulus (Chapter 13: Stabilization Policy. Chapter 9: Income-Expenditure and the Multiplier.)
2001-10-21: Federal Reserve Reaction to the Terror Attack on the World Trade Center (Chapter 13: Stabilization Policy. Chapter 10: The IS Curve.)
2001-10-14: Why a Stimulus Package Might Be Desireable (Chapter 13: Stabilization Policy. Chapter 10: The IS Curve.)

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