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Why did the ecb respond less aggressively than the us federal reserve to the crisis

Fighting the wrong enemy? Paul De Grauwe Although the Great Recession was viewed — especially in Europe — as mainly a US problem, the Eurozone has been implicated from the start and felt virtually the same impact in the early stages Figure 1. The US economy, why did the ecb respond less aggressively than the us federal reserve to the crisis recovered much faster. US stock prices and GDP regained their pre-crisis levels by late-2011; the Eurozone barely reached that stage in 2015.

Fiscal stimulus was greater than in the Eurozone in 2008-9; the US also returned to fiscal austerity later, in 2011 rather than in 2010 as the Eurozone did Mody 2015. And throughout, US monetary policy was much more aggressive. In a recent paper, we used a narrative approach to identify the role of monetary policy during the Great Recession Kang et al. The policy rate was brought to near-zero only in November 2013; modest quantitative easing began in September 2014 and was expanded in January 2015.

The US Federal Reserve and the ECB Our narrative tracks the stated policy intent, the stock market response following the announcement, and the immediate market commentary. This is measured as the change in the stock price minus the average daily change over the 20 days before the announcement the presumption is that absent the announcement, stock prices would have continued to change at the same pace over the next five days. Adding up the daily abnormal differences, the cumulative abnormal difference shows the post-announcement divergence in the stock price movement from the trend in the preceding 20 days.

The results are summarised in Figure 3. Stock market reactions to the reduction of interest rates Note: The results remain unchanged. Consistent with our findings around the announcements, US stock indices moved ahead of those in the Eurozone, as seen in Figure 1. Active stimulus The anticipation of the announcements was not the primary influence on stock prices.

In the US, the one unexpected announcement did trigger a strong response; but even the anticipated rate cuts were viewed favourably, especially if they were 50 basis points 0. The ECB was reacting to news—building its shelter amidst a raging storm. ECB statements also mused endlessly about rising inflation and hence almost never promised more forthcoming action. The Bank of England was also late, but made up with quicker and much larger rate cuts, followed by quantitative easing. It is true that the Fed has a clear dual mandate to support employment and maintain price stability.

The ECB—despite its primary focus on price stability—had previously responded as if it had a dual mandate. The priority was to prevent or manage that risk.

Board of Governors of the Federal Reserve System

Between 2007 and 2009, the Fed made the judgement that inflation risk was low and the main task was to prevent a downward output spiral. Later, the Fed used the same risk management approach to fend off the risk of price deflation.

By contrast, the ECB concluded that a temporary scare had caused banks to hoard cash and restrict lending to other banks Blinder 2013, p. Thus, the ECB provided ample liquidity to banks, although no more so than the Fed. As the Fed understood, such passive provision of funds to banks was insufficient to induce banks to lend more and stimulate economic growth Hetzel 2012.

The loss of confidence and severe demand contraction required active monetary stimulus. Trichet and Papademos 2008. The essential difference between the Fed and the ECB, therefore, boiled down to how each institution viewed the evolution of the economy. Even though inflation rates in the US and the Eurozone were nearly identical Figure 4the ECB overemphasised the risk of a commodity price-wage spiral and underestimated the financial and economic risks Hetzel 2014.

Market commentary repeatedly sent this message, as we document in our paper. Headline inflation and core inflation for the US and Eurozone Note: Forestalling deflation The Fed transitioned to worrying about deflation risk as early as June 2010, even though inflation was rising in tandem with the European inflation rate Figure 4 Federal Reserve System 2010.

As is well known, in this inglorious interlude, the ECB twice raised interest rates. But even past that point, the ECB continued to reject a risk-management approach and followed rather than anticipated the deceleration in inflation. Because it had delayed stimulus during 2007-9, the ECB needed more aggressive action rather than a continued wait-and-see approach.

Thus, the ECB acted asymmetrically: Once again, markets and analysts reacted impatiently. Interest rate cuts were not enough. Policy credibility We conclude also that the Fed gained credibility even though it appeared to temporarily suspend its commitment to price stability. Bordo and Kydland 1995 have argued that setting aside a policy rule to deal with extraordinary contingency is consistent with a commitment to long-term goals.

The Fed made clear its objective of preventing a meltdown and, as Blinder 2012 has emphasised, credibility principally requires that words be matched with deeds.

Fixing the European Central Bank – Lessons from the US Federal Reserve

In the Eurozone, words were often a substitute for deeds. Markets and investors reacted to the tight monetary policy, which added to the economic drag and deflationary tendencies due to fiscal austerity and lingering banking problems.

  • Concluding Remarks To summarize and conclude, the Fed's statutory objectives are defined by its dual mandate to pursue maximum sustainable employment and price stability in the U;
  • For asset prices, the strongest evidence came in the form of reduced foreign bond yields, but valuations of foreign currencies and stock prices also increased appreciably in some cases;
  • In fact, it bears mentioning that, following the taper tantrum, when the Fed started to taper its purchases, there was little reaction from markets;
  • And, since the U;
  • In the Mundell-Fleming framework, as well as in modern developments of the same theme, a shift toward a more accommodative monetary policy in the United States spills over to foreign economies by causing their interest rates to fall--though typically by less than in the United States--and their currencies to appreciate against the dollar;
  • We did so in recognition of the scope of dollar markets and dollar-denominated transactions outside of our country, the benefits they provide to U.

By mid-2009, Eurozone output had fallen behind that of the US, and it never caught up. Delays in stimulating economic recovery have permanent consequences, as recent analysis reaffirms Fatas and Summers 2015. For all its rear-guard action, the ECB misread the Crisis and will be associated with the legacy of a weak recovery and more entrenched deflationary tendencies. Blinder, A 2013After the Music Stopped: Hetzel, R 2012The Great Recession: Market Failure or Policy Failure, Cambridge: