Lagarde should worry less about the Germans now

The stakes couldn’t be higher for Europe. With the US Federal Reserve aggressively cutting interest rates to buoy the US economy in the face of the Covid-19 crisis — and the Bank of England following suit — a “too little, too late” policy on the part of the European Central Bank risks sending the euro soaring to uncompetitive levels and Europe into recession.
European policymakers should keep in mind that in March 2015, it was the soaring euro that forced the ECB to adopt quantitative easing to bring its monetary policies in sync with those of the US, which had begun easing in 2008. The ECB had sought initially to take an independent path and not resort to QE but the euro rising to $1.40 put a stop to that.
Former ECB President Mario Draghi, whom I met with regularly during that period to
discuss this very issue, understood and fretted about the fact that the Germans would be very much against the move to QE. He nonetheless chose to protect the entire euro zone economy from deep recession and possible deflation, incurring the wrath of ECB hawks and Germans in the process.
That is precisely the model that the ECB should follow in the face of the coronavirus crisis; if the central bank wants to avoid a surging euro in addition to the direct economic dislocations attributable to the virus, the key is to get its monetary policies as stimulative as those in the US.
That seems unlikely under Draghi’s successor, Christine Lagarde. The recent arguments made by several ECB officials, that the best way to counteract the economic effects of the virus is fiscal policy, not monetary policy, hint of a “too little, too late” response that significantly raises the odds of a soaring euro and recession.
So far, apart from Italy, there has been no large-scale fiscal policy response from EU countries to match the monetary stimulus in the US (or the fiscal measures now under consideration from the Trump administration). That may change as Britain unveiled its new budget, and as the virus spreads to more regions.
What is particularly worrisome about the Covid-19 crisis is that it comes at a time when Lagarde is pursuing a political agenda of restoring unity to the ECB’s governing council and improving the ECB’s standing in Germany. That agenda made good sense. Years of QE built up resentment among German savers; many saw it as an expensive subsidy for poorer, less fiscally prudent euro zone countries.
Largarde’s strategy increases the chances that the ECB will make a major policy mistake. To promote unity on the governing council, Lagarde is showing sympathy for the argument that the ECB is running out of ammunition, a
line ECB hawks such as Austrian Central Bank Governor Robert Holzmann, the Dutch central banker Klaas Knot and Bundesbank President Jens Weidmann have been pushing to limit further monetary
stimulus.
—Bloomberg

Melvyn Krauss is an emeritus professor of economics at New York University and senior fellow at the Hoover Institution, Stanford University