What is the European Central Bank Thinking?

Willem Buiter has an excellent post up at the FT asking, basically, why on earth the European Central Bank is sitting on its hands while the Euro area undergoes inflation. He points out that its attitude toward deflation is both dumb and in violation of its legal mandate under the treaty establishing it:

The asymmetry in the response of the ECB to inflation rates above the level deemed consistent with price stability in the medium term, as opposed to inflation rates below that level is staggering and poses a material risk to the independence of the institution. [...] The ECB is violating its price stability mandate by tolerating, aiding and abetting deflation in the Euro Area.

Buiter observes that recent changes in the relative position of the “core” vs “headline” inflation rate give us a case study in this asymmetry:

When the headline rate was high but the core rate was below the ECB’s long-term 2 percent target, the ECB emphasized the headline rate and tightened monetary policy. But now that the headline rate is negative, the ECB chooses to emphasize the core rate and decline to ease further. I would note, in addition, that even the core rate is substantially below the ECB’s self-proclaimed target.

When I was in Germany, my group had the opportunity to speak with Bundesbank President Alex Weber. Unfortunately, the discussion was off the record. But suffice it to say that in keeping with stereotype, rather than in keeping with the actual legal mandate of the ECB, Weber’s point of view is very much that this kind of asymmetry is appropriate and he was very committed to the idea that the purpose of central bank independence is to allow one to be indifferent to the human consequences of this kind of commitment to low inflation at all costs. That really doesn’t seem correct to me. Among other things, as Buiter says it seems to me that this behavior is actually threatening the ECB’s independence. It’s one thing to go against a plain reading of your legal mandate. And it’s one thing to allow employment and production to become depressed. But to do the two simultaneously is willfully playing with fire.

The rubber hasn’t really hit the road on this issue yet since the recession’s not that bad in France and Germans are maniacal about inflation. But things are really falling apart in Spain and Ireland and the Germans are probably looking at a big run-up in unemployment soon, too.