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Europe’s Selfish Monetary Policy

23 Feb 2022
By Heribert Dieter
President of the European Central Bank Christine Lagarde delivers the Per Jacobsson lecture, “Globalization After The Pandemic,” during the 2021 Annual Meetings at the International Monetary Fund.
Source: IMF Flickr/Allison Shelley,

The low interest rates of the European Central Bank have greatly benefited European companies. While the undervalued euro helps exporters in the short term, it may seriously harm the continent in the long term.

Twenty years after the formal introduction of the euro, many observers looked back at the single currency’s evolution and prospects. In particular, scholars have focused has on the record of the European Central Bank (ECB) regarding the control of inflation. But the effects of the ECB’s policies for the rest of the world have largely been ignored. This is surprising — since about 2010, the countries of the European Monetary Union (EMU) have pursued a strategy of undervaluation, a mercantilist monetary policy. By applying the lowest interest rate of any major central bank, the ECB has made the euro a weak currency. The effects of that policy are primarily felt in the developing world rather than in other OECD-countries. The ECB’s policies have allowed the bloc’s exports to rise — at the expense of poorer economies.

The ultra-loose monetary policy of the ECB has affected the exchange of the euro. It is weak against all OECD-currencies, particularly the dollar. The result of the ECB’s policies is an increase in the competitiveness of companies from the monetary union in non-European markets. Between 2010 and 2020, the bloc’s trade surplus has risen from €29.4 billion to €340.7 billion. But why is nobody criticising these effects? The answer is quite simple — Washington is no longer interested in the matter, and the other victims of the ECB’s selfish policies have no voice.

Washington’s lack of interest in criticising the Europeans is easily explained. Unlike Donald Trump, President Biden has not been emphasising the fight against unfair competition by European economies. More importantly, however, the US economy is humming along nicely. There is no shortage of jobs. The unemployment rate has remained at the low level of four percent in January, and more than 10 million positions are unfilled. Joe Biden simply does not have to worry about Europeans taking advantage of the undervalued exchange rate of the euro. By contrast, a strong dollar results in higher purchasing power of US citizens both at home — imports are cheap — and abroad. At the same time, the strong currency makes controlling inflation easier, due to the effect on import prices.

The effect of the ECB’s policies for European citizens is, of course, quite different. A weak euro diminishes their purchasing power, again at home and abroad. But who benefits from the ECB’s strategy of weakening the euro? The manufacturing sector of the eurozone. Shareholders of manufacturing companies, as well as those employed there, have been supported by the significant undervaluation of the common currency. Within the monetary union, German companies in particular have enjoyed an export frenzy for years.

The monetary policy of the ECB contributes to the bloc’s trade surplus. While Brussels continues to emphasise that it is interested in supporting poorer economies in Asia and Africa, the weak euro has the opposite effect. Rather than facilitating an export-led economic upswing in Europe’s southern neighbourhood, the currency’s weakness helps to create jobs and income in the EMU economies. Of course, that is a positive outcome for Europeans, but it also strongly encourages migration to access said jobs. A mature European Union ought to have a much lower trade surplus if any at all.

Will the situation change when the Federal Reserve and other central banks raise interest rates? Whilst a tightening of European monetary policy appears necessary now to avoid a further erosion of the euro’s exchange rate, it will arrive late. The European Central Bankers have signalled in in January and February that they are considering a departure from the ultra-loose monetary policy of the last decade, but Europe will still be trailing the US and other economies. The exchange rate will not rise against the dollar simply because interest rates in Europe will – for the time being – continue to be lower than elsewhere, with the notable exception of Japan.

In fact, the ECB may have created a scenario from which there is no easy escape. If it fails to tighten monetary policy, it may well be confronted with a level of inflation closer to the levels seen in Italy before monetary union rather than German levels. At the same time, given that member countries of the EMU have not used the breathing space created by the ECB to make their budgets more sustainable, a rapid tightening may push some economies to the brink, or beyond.

Mario Draghi’s often quoted statement — “the ECB will do whatever it takes to preserve the euro” — signalled that the ECB was willing to go beyond its remit. Today, Christine Lagarde, current president of the ECB, will have to draw a line and return to a more narrowly defined understanding of monetary policy. Given the high levels of public debt in many EMU-member countries, such a step will require courage. Considering Lagarde’s record at the International Monetary Fund, where she presided over the ill-fated loans to the Argentinean government of Mauricio Macri, it appears unlikely that she will be ready to implement significant monetary tightening any time soon. The ECB will probably continue to implement a mercantilist monetary policy.

Of course, there are significant risks to that approach. Whilst Europeans may not revolt against the undervaluation of the euro against other currencies, significant inflation will be politically dangerous. In Germany in particular, the two hyperinflations of the 20th century — both 1923 and the currency reform of 1948 wiped out the savings of most citizens — have left their marks in collective memory. Although European integration enjoys broad political support in Germany, lasting inflation has the potential to erode it.

Nevertheless, the ECB will not consider the effects of the undervalued euro any time soon, simply because there is no political pressure to do so, at least not yet. European policy makers prefer to ignore the negative effects of their central bank’s monetary policy for the rest of the world. At the same time, Washington is so preoccupied with the geopolitical conflict against the People’s Republic of China that is does not wish to alienate its European allies.

Heribert Dieter is a senior fellow at the German Institute for International and Security Affairs, Berlin, and a professor at the University of Potsdam.

This article is published under a Creative Commons License and may be republished with attribution.