Steering Monetary Policy Through Unprecedented Crises

In early April 2008, economic conditions in Europe appeared to be deteriorating on almost all fronts: sales figures were falling, business and consumer confidence were slumping, forecasts for European growth were being revised downward, and inflation was rising. In fact, figures for the month of March revealed that inflation had reached an annualized rate of 3.5%, Europe's highest level since 1992. On top of these broad economic problems, the European financial sector–indeed, the financial sector worldwide–was in turmoil. By April 2008, global financial institutions had written down the value of their mortgage-related investments and other assets by at least $230 billion, and businesses around the world were complaining that it was ever more difficult to secure credit. In America, meanwhile, consumer confidence was falling, consumer spending had slowed to a near halt, and inflation had crept above 4%. In reaction to these dismal economic conditions, the Federal Reserve had steadily cut interest rates over a seven-month period, most recently lowering its key rate to 2.25% on March18. In sharp contrast to the Fed, the European Central Bank (ECB) had long held its key rate at 4%, where it stood when the ECB's Governing Council reconvened on April 10, 2008. Given both the market turmoil and the evident inflationary pressure, members of the ECB's Governing Council would have to weigh the available data extremely carefully as they decided whether to raise, lower, or maintain their benchmark interest rate. The significance of this decision could hardly be overstated, since it had the potential to send a strong signal about the nature of European monetary policy and the priorities of the ECB going forward.