By Alexander Apostolides on March 04, 2009

Dr. Orphanides vs Deutche Bundesbank? - not really.

I thought they were rumors but it seems Bloomberg also hints at a rift within the ECB. According to the article the Fed trained Dr. Orphanides, president of the central bank of Cyprus, is pushing the ECB to drop interest rates even further.

What the article seems to ignore here is that the ideological division within the ECB is taking place between people who accept the same principles of economics, i.e. this is not a rift between Catholicism and Protestantism but a debate over the proper reading of the scriptures within the Catholic orthodoxy.

All in the ECB believe in the basic monetarist tenets: the money market has a direct impact on the real economy and peoples incomes, and thus interest rate reductions stimulate the economy (or increasing inflation) even in the current economic climate.

Thus this so called "battle" is not battle of ideas but more a disagreement of versions of history. Dr. Orphanides is evidently a believer of the Bernanke (Head of the US Federal Reserve) / C. Romer (Chair of the US Council of of Economic Advisers) view of the Great Depression. The Romer / Bernanke synthesis argues that the recovery from the Great depression was due to an expansionary monetary policy and the restructuring of the banking sector. Others in the ECB, possibly led by Professor Axel Weber, president of the Deutche Bundesbank, have the horrors of stagflation of the 1970s and the hyperinflation of the 1920s firmly entrenched in their mind. In their interpretation of the same monetarist tenement, inflation is dynamic and comes after a lag of 6 months to a year after a interest rate cut; it is simply not worth having future inflation in order to prevent a possible reduction of output today as the cost of inflation in terms of future lost productivity far outweighs the effects of a current downturn. Both schools see the restructuring of the banking sector as crucial, and i am sure they feel hampered by the diverse responses of the EURO-area countries in terms of bank restructuring, where the ECB has no direct input.

However the issue facing the world is that economics are not united in providing responses to the current crisis. Rather than accepting any one school of thought, a collection of different policies drawn from all schools would surely provide a better outcome, due to the fact the objectives of each school are as diverse as the needs of the policymakers.

It is not clear if the monetarism has the answer to the needs of politicians in increasing output and providing employment; some economists argue that interest rates are so low that we have fallen below the threshold where monetary policy ceases to be effective, thus falling in a "liquidity trap". According to Neo-Keynisian economists (who also sit in the council of economic advisers) what is needed is direct investment in the real economy by the government (more schools, roads, ect) in order to safeguard jobs and increase output - interest rates cuts simply will not work anymore.

While there might be a definite disagreement on what the monetarist solution is for Europe, both parties within the ECB accept that the ECB holds the answer and fiscal policies of the respective European countries are at best complimentary but at worst unhelpful. However, the debate for the way out of the current global mess needs to take place by taking all schools of economic thought into account in order to have a correct policy response. Yet strangely enough the focus has been on global action without having a global discussion on what is the way froward in terms of economic theory.

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