The ECB's progress 10 years on

Analysis
By Stephanie Flanders
Economics editor, BBC News

Even the greatest fans of the ECB would agree that it didn't get off to a great start.

The ECB has been applauded for its response to the credit crisis

But a rising currency, better communications skills and a quick response to the credit crunch have strengthened the bank's standing at a time when central banks everywhere are under pressure.

"In the past year, the ECB has emerged as one of the cornerstones of stability in the global financial system," says Richard Reid, a senior economist at Citigroup.

"There's growing appreciation of what it has done."

'Anti-growth bias'

Things were very different in the early years, when the Euro was dubbed the "toilet currency" as it fell to record lows against the dollar.

At the time, there was also much carping about the communications skills of the man at the top.

"The first President, Willem Duisenberg, was not very good at dealing with the press. He had other virtues but that wasn't one of them," comments Professor Richard Portes at the London Business School.

"There were some notorious slips in talking about the currency, and the regular press conferences were not distinguished by clear communication to the markets."

Over the years, Mr Duisenberg and his successor Jean-Claude Trichet, who took over in 2003, were also criticised for putting inflation before growth.

Despite slow growth in much of the Eurozone, the bank often refused to give in to European politicians' demands to loosen policy.

This was during a period when the US Federal Reserve, under the leadership of Alan Greenspan, was distinguished for its willingness to keep interest rates low.

Many US economists suggested that the ECB had an "anti-growth bias".

Economic growth in the Euro area has averaged only 2.1% per year since 1999, compared with 2.6% in the US.

Change of heart

But these figures flatter the US, since America's population is also growing much faster than Europe's.

Gross domestic product per capita has actually grown slightly faster in the Eurozone over the past 10 years - by 1.8% a year on average, compared with 1.6% in the US.

From day one of the credit crunch, the ECB has had a sure-footed approach to the market

Richard Portes, London Business School

This realisation has led some of the ECB's critics to have a change of heart.

Recently, many also think it has responded better than other central banks to the credit crunch in financial markets that began last August.

"From day one of the credit crunch, the ECB has had a sure-footed approach to the market," says professor Portes.

"It was willing to take the risk of injecting liquidity when liquidity was desperately needed. That kept their interest rate down much closer to the policy rate than in the US or UK."

Mervyn King, the governor of the Bank of England, has pointed out that the ECB's public "injections" of funds in the money markets have largely been counterbalanced by withdrawals from other parts of the market.

As a result, the net increase in liquidity in the Euro money markets has actually been more modest than in the UK.

But Professor Portes thinks this is a moot point.

"The ECB may have done less than it seems on the liquidity front, but it's the perception that matters. The fact that the markets think it has done more has helped them support confidence more effectively than in the UK."

Inflation

Though European multinationals with markets in the US are already being squeezed, the full effects of the credit crunch have yet to be felt in the Eurozone.

Some think it's only a matter of time.

But others say the area will be less affected, partly because the ECB's higher interest rate policy helped to protect the eurozone economy from the worst excesses of the global credit boom - even though there were noticeable exceptions, such as Spain and Ireland.

If so, it will be easier for the ECB to deal with its other great problem these days - rising inflation due to higher prices for food and fuel.

Inflation in the eurozone has averaged around 2% since monetary union, compared to 3% in the 1990s and 8-10% in the 1980s.

But inflation in the euro area is now running at 3.6%, far above the ECB's target of "below, but close to 2%".

"For the past few weeks, inflation rates in euro area countries have been coming in above expectations," says Richard Reid.

"The ECB will be keen to show it won't let this feed through into second-round inflation in prices and wages. The past year has given it the credibility to pursue that policy with vigour."

Stronger shape

After years of being compared unfavourably with the US central bank, ECB officials will be taking quiet satisfaction from the fact that the Federal Reserve's anti-inflation credentials are now under attack.

But they would be wise to remember how quickly opinions can change.

Only a few months ago, the Fed was being praised for its aggressive response to the US slowdown.

Now that the fear of recession has receded a little, it is under attack for loosening its grip on inflation and debauching the dollar.

Jean-Claude Trichet could face a similar reversal if the Eurozone economies slow down rapidly in the next year, just as the ECB moves to raise interest rates to tackle inflation.

Like every central bank right now, the ECB has some big challenges ahead.

But one thing is clear: it is entering its second decade in much stronger shape than its first.