Paul Krugman recently drew a parallel between the Federal Reserve’s plans to raise interest rates in 2015 and the ECB’s ill-fated 2011 policy tightening, which was swiftly followed by a recession. The monetary context is different, however, casting serious doubt on the comparison.
Former ECB President Jean-Claude Trichet bears the unfortunate distinction of having raised rates on two separate occasions in the teeth of an oncoming recession – August 2008 and April / July 2011 (a double increase). These decisions were astonishing from a monetarist perspective because they were taken against the backdrop of a contracting real (i.e. inflation-adjusted) money supply, as measured by the narrow M1 aggregate – see chart. The associated recessions, in other words, would have occurred anyway but were certainly magnified by the ECB’s actions.
US real M1 growth has fallen back since mid-2014 but remains at a respectable level. A pick-up around end-2013 signalled economic strength in mid-2014 – GDP is currently estimated to have grown at a 4.2% annualised rate in the second and third quarters, although this partly reflects payback for a weak start to the year. The recent real M1 slowdown may herald a moderation in GDP expansion to a 2-3% pace. Monetary trends would need to weaken significantly further to suggest economic danger from a small interest rate rise.
Professor Krugman’s worries, therefore, are premature. The ECB, meanwhile, may be repeating its 2008 / 2011 mistakes in reverse, with President Draghi and his allies seemingly determined to push through sovereign QE in early 2015 despite recent strong monetary growth and building evidence of an economic upswing.
