In the Financial Times, Martin Feldstein wrote about the difference between the EU and US monetary setting regimes – specifically he wanted to answer why the EU was lifting rates, while the US had been cutting. (ht Greg Mankiw).
Ultimately, he puts this difference down to a number of factors:
- Labour market differences – stronger unions in Europe make a wage-price spiral more likely.
- Inflation history – EU has had more episodes of hyperinflation
- Age and credibility – EU body is young, this is its first major crisis, still needs to get credibility.
Now these appear to be good reasons why reactions differ between the two countries.
However, just to make this post a little more complete there could be some other reasons why the cash rate may differ between countries:
- Time preference – the more we prefer consumption now to the future, the greater interest rates need to be to reduce inflationary pressure (less so for a small country).
- Inflation fighting history – if they have been more dovish in the past, they will need higher rates now.
- Natural economic growth – the greater the natural growth rate, the higher the interest rate needs to be.
- Relative risks in the country – the higher the relative risk in the country, the higher the real interest rate needs to be.
- Marginal product of captial – the higher the marginal product of capital, the greater the real interest rate must be.
Anything I’ve missed?