Undoubtedly, being responsible for the monetary policy of a common currency bloc of more than a dozen different countries can be a thankless task at times. Mario Draghi could certainly tell us a thing or two about it – shoehorning every member state into a one-size-fits-all monetary policy is uncomfortable all round and leads to criticism of the shoemaker, in this analogy Mr Draghi.
Arguably, Mr Draghi’s biggest critics inside the union come from Germany. Adding to Wolfgang Schäuble’s regular moaning about the ECB’s monetary policy, two weeks ago, Andreas Dombret, Member of the Board of the Deutsche Bundesbank, gave a speech in which he analysed housing market developments in Germany. He argued that house price inflation in Germany is alarmingly out of line with economic fundamentals. It seems that, like foot size, different people have radically different thresholds for deeming something alarming…
As the title of one of the sections of his speech Mr Dombret used the German version of the proverb “Better safe than sorry”. It hits the nail on the head when it comes to the Bundesbank’s attitude towards monetary policy.
At least Germany and the other member states have in a sense agreed to this deal, implicitly accepting that in the end their economies must adapt to fit the common monetary policy, not the other way around. But it’s doubly hard for Mr Draghi if non-member states insist on wearing the same shoe size, so to speak, and then complain that it doesn’t fit. That’s the case now in the Scandinavian economies outside the euro area. Denmark, Norway and Sweden, countries who don’t even have a vote on the Governing Council, consider the ECB’s monetary policy too loose.
All three are small open economies that are highly dependent on trade – in all three cases, exports to the euro area account for roughly 10 per cent of GDP. To stay competitive, Danmarks Nationalbank, the Norges Bank and Riksbank have cut policy rates in lockstep with the ECB, thereby driving house prices to unsustainable highs. As our chart illustrates, since the ECB started cutting interest rates in 2011 house price inflation in all three countries has exceeded growth in households’ disposable income, most dramatically in Sweden. What is worse, in contrast to Germany, house prices in the three Scandinavian countries were already overvalued.
The hands of Danish central bankers are tied since the Danish krone is pegged to the euro. By the same token, a meaningful increase in interest rates would cause the Norwegian krone and the Swedish krona to appreciate against the euro, and hence undermine both inflation – already below target in both countries – and economic growth. Then again, continuing expansive monetary policy will fuel the house price bubble further. All three central banks feel they are caught between a rock and a hard place, but they are mistaken. They retain the ability to set monetary policy, fiscal policy and macro-prudential policy independently, and they should use it. They should find a shoe that fits, and maybe some other clothes, too.
Scandinavian policy makers could and should take a page from the Bundesbank’s book and lean against the wind. And, before they lay the blame for their own housing markets overheating at the door of Mr Draghi, they should walk a mile in his shoes. Because, as the joke goes, then they’ll be a mile away, and they’ll have his shoes.