A rather surprising announcement was made today by Mr. Axel Weber, the head of the Bundesbank. The Chairman said at a press conference held in Frankfurt that he sees no need for interest rates to fall below 1%.
Being the largest central bank from the Euro-area and one of the initial founders of the European Central Bank, the Bundesbank certainly has a huge influence over the monetary policy of the ECB. As such, Mr. Weber’s comments can easily be taken as the position of the ECB.
Additionally, the Bundesbank has changed the face of monetary policy by managing to keep inflation down at a time when every major economy in the world had double digit Consumer Price Inflation (CPI). The Bundesbank’s strategy was to anchor expectations by using public speeches and appearances, a strategy that was later used by most central banks to guide expectations (and is still being used).
Over the past few months, ECB officials have repeated that they do not see the need to send the interest rates too low, because it would risk drying up the inter-banking funds. However, this view is not shared by most market participants, who strongly believe that the ECB is way behind the curve on lowering rates.
The main “counterexample” for the ECB’s actions is the Fed, which cut rates as much as it could at a breath-taking pace. The Fed’s view is influenced by a number of academic papers, which say that if the Fed would have cut more in the 1930’s, the U.S. economy may have avoided the Great Depression. This view is strongly supported by Mr. Bernanke, but Nobel winner Paul Krugman has stated lately that this strategy has failed to do anything new. Additionally, the U.S. economy is starting more and more the look like Japan of the 1990’s.