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The Fed is from Mars, the ECB is from Venus

By Neil Irwin

When I was in Frankfurt last month for meetings at the European Central Bank, I was shocked at times at how different the tone was compared with their counterparts at the Federal Reserve, whom I spend most of my time covering. In two days at the ECB (and two days speaking with many German economists for two days before that), I heard almost zero references to the unemployment situation in Europe or the plight of the jobless.

Instead, they speak with pride of their success at keeping prices stable--which is valid enough, but from an American vantage point, not exactly something to brag about when most of the Eurozone is experiencing double digit unemployment.

That is all a prelude to help you understand the latest from ECB president Jean Claude Trichet. In an opinion article in the Financial Times today, Trichet lays down the gauntlet: It is time, he writes, for governments around the world to pull back, to reduce spending and raise taxes.

"It is reassuring that the consensus on the need for credible fiscal exit strategies . . . is very broad," writes Trichet. "But the timing remains disputed. In the waiting camp, some argue that it would be desirable to maintain or even increase the fiscal stimulus to avoid jeopardizing the economic recovery. Others claim that fiscal consolidation will have a negative systemic impact on the global economy by damping the growth environment. I disagree with both these views. We have to avoid an asymmetry between bold, if justified, loosening and unduly hesitant retrenchment."

Translation: OK, United States. You've had your fun, spent your money, and propped up growth. But you've now spent so much that you (and other developed countries) are now at risk of abrupt crises of confidence, and unless you start pulling back now, you won't have maneuvering room with which to fight it.

"With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: 'stimulate,' 'activate,' 'spend!'" Trichet wrote, saying that the advice should have been better tailored to individual countries situations.

This is a decidedly different tone from the one that Fed Chairman Ben S. Bernanke offered in congressional testimony this week. The medium to long-term deficit is very much a problem, he argued, and Congress needs to deal with it. But the near term is different.

"I do believe at the current moment that the large deficits, as unattractive as they are, are important for supporting economic activity," Bernanke told the Senate Banking Committee Wednesday, "and they were important also in restoring financial stability. And so I think they were justified in that respect, and I would be reluctant to withdraw that support too precipitously in the near term."

Why are the world's two most important central bankers so different on this point? Part of it is structural. Bernanke's Fed has a dual mandate from Congress, of maintaining maximum employment and stable prices, and the Fed is most falling short on the first front now, given the 9.5 percent unemployment rate. Trichet and the ECB has only a single mandate, to maintain stable prices, and he takes it seriously.

Second, Trichet is a career central banker and financial crisis-fighter, rather than a macroeconomist. He views containing the risk of a crisis--such as an abrupt loss of investor faith in the debt of the U.S., Britain, or another major economy--as the greatest thing to fear, rather than a prolonged period of unnecessarily high joblessness. Bernanke the macroeconomist looks at high unemployment and sees that as the first-order problem.

Third, Bernanke is more directly accountable to political authorities than Trichet. Bernanke spent two days this week answering questions from members of Congress who are angry that their constituents are still unemployed; Trichet may have private meetings with heads of state, but he spends most of his time in the banking capital of Frankfurt surrounded by people like him, not as exposed to the political maw.

By Neil Irwin  |  July 23, 2010; 12:33 PM ET
Categories:  Budget and fiscal policy , Federal Reserve , International Economics  
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