The difference between US and European monetary policy

Europe Shuns U.S.-Style `Active Role' on Economy, Bank Bailouts
By Simon Kennedy and John Rega

Sept. 15 (Bloomberg) -- European finance ministers and central bankers said they had no plans to follow the U.S. in stimulating their economy and failed to agree on ways of rescuing any foundering financial institution.

As U.S. officials in Washington monitored the slide of Lehman Brothers Holdings Inc., European policy makers concluded talks in Nice, France, without breaking new ground on how to share the bailout cost if a bank collapse threatened to spread across the region. They also signaled restraining inflation and budget deficits was a better strategy to revive economic growth than lowering taxes and interest rates.

``U.S. policy makers have generally taken a more active role in supporting the economy and stabilizing financial markets, while the euro zone has opted for a less-interventionist stance,'' said Natacha Valla, a former economist at the European Central Bank and now at Goldman Sachs Group Inc. in Paris.

The transatlantic divide in monetary and fiscal policies may mean the economy of the 15-nation euro region takes longer to rebound after contracting 0.2 percent in the second quarter. The European Commission projects the weakest growth since 2003 this year as Germany and Spain slip into a recession and Italy and France stagnate.

``Europe faces a long-lasting slowdown and only gradual recovery,'' said Dario Perkins, an economist at ABN Amro Holding NV in London.

Cost-Sharing Plan
The lack of a cost-sharing plan means the pain would be even greater should a pan-European financial institution run into troubles similar to those that battered Bear Stearns Cos., Fannie Mae and Freddie Mac in the U.S., said Nicolas Veron, an economist at Bruegel, a Brussels-based research organization.

Ministers have so far agreed only to knit bank supervisors closer together and pledged to cooperate in managing any crisis. Unwilling to commit taxpayer money up front, they resisted calls to devise a plan for splitting the bill should a bailout become necessary to prevent a collapse of the financial system.

``The policy response would be slower and less efficient given the lack of a framework and that would pose a significant cost to the economy if something happened,'' said Veron.

By contrast, the U.S. has been able to step in swiftly to help ailing institutions. The government this month assumed control of Fannie Mae and Freddie Mac, while in March the Federal Reserve helped finance JPMorgan Chase & Co.'s purchase of Bear Stearns.

Biggest Banks
The U.S. has the advantage that the institutions it monitors are largely contained within its borders. Europe's biggest banks held an average of 24 percent of their assets in European countries other than their own in 2006, double the amount of 1997, according to Bruegel.

European policy makers also face more constraints than their U.S. counterparts in responding to weakening growth. One is inflation, which remains above the ECB's 2 percent limit. Governments have their hands tied by EU rules that require budget deficits to be below 3 percent of gross domestic product.

Neither restraint exists in the U.S., allowing the Fed to cut its benchmark rate to 2 percent and President George W. Bush to enact $168 billion of stimulus. Europe's strategy amounts to a bet that expansion can be better revived by controlling inflation and budgets than by pump-priming growth with short-term stimulus that generates higher prices and bigger deficits.

Spending taxpayers' funds on fiscal programs to spark growth would be ``like burning money,'' German Finance Minister Peer Steinbrueck said. Luxembourg Finance Minister Jean-Claude Juncker questioned the success of the U.S. approach, and said declines in the euro and oil price would help Europe.

Fiscal Easing
``This should calm the ECB a bit as it increasingly fears that fiscal easing would oppose the central bank's efforts to bring down inflation over time,'' said Juergen Michels, an economist at Citigroup Inc. in London.

ECB President Jean-Claude Trichet, who has demanded governments control their budgets, said the test would be ``implementation in practice.'' Price stability remains the bank's ``fundamental concern,'' he said.

Rather than driving up deficits, the European officials said they plan to cushion their economy by allowing automatic stabilizers such as higher welfare payments to kick in. They also pledged to make their economies more flexible, increase financial- market transparency and lend more money to small- and medium-sized industries.

``We're not going to sit on our hands,'' French Finance Minister Christine Lagarde said. Still, slowing growth alone will be enough to end four years of fiscal consolidation with JPMorgan predicting a budget deficit of 2 percent of GDP in the euro area next year, up from 0.6 percent last year.

Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Plc., predicts an extended period of weak growth may prompt countries such as France and Italy to ``exploit'' a revised rule that allows a temporary breach of the limit in times of weak expansion. Italy, France, Ireland, Portugal and Greece are at risk of breaching the deficit ceiling next year, according to Commerzbank AG.