LUXEMBOURG, April 10 - European Central Bank Governing Council member Yves Mersch said on Thursday that the winding down of the Iraq war may lift one veil of uncertainty but others remain. "It is absolutely premature to say all uncertainty is behind us," Mersch told in an interview. "I don't dispute that there is room (for lower interest rates), but that's not the only question." Global security issues will linger in this new world of terrorism, and the costs of handling it are unknown, he said. Central bank policymakers must ask questions about the long-term consequences of the war on terrorism on trade, globalisation, foreign direct investment, confidence and travel.
He said the world may be on the brink of fundamental geopolitical changes that alter the course of economics. "Is this (war) only an accident, or is it a paradigm change," Mersch said. Discussing these issues at international meetings such as the Group of Seven finance ministers this weekend will be extremely helpful, he added. Against such an uncertain backdrop, Mersch said decision making is more difficult. "One cannot say that uncertainty has gone when confidence, both business and consumer, is at its lowest in 10 years." In Europe, there are structural difficulties. In the United States there are the twin deficits in trade and public finances and there is also the growing budget deficit in Japan. "How will the U.S. address the twin deficit now that the war is over. Who will pay the bill? The U.S. is a big economy and if you have uncertainty on private consumption, external demand, investment and public finance, you begin to ask where growth should come from."
"This was one of the primary reasons we did not move (interest rates) in Rome," Mersch said. The Iraq war had obscured other issues but policy makers have now begun to think normally again about economic factors and would assess how they reacted to the war and how they may develop in the future, he added. The ECB left its key interest rate unchanged at 2.50 percent at its policy meeting last week, saying international uncertainty was clouding the horizon of policy makers.
"WAIT-AND-SEE" ON INTEREST RATES
ECB President Wim Duisenberg said after the decision that the central bank had no bias, neither in the direction nor the amount of any policy change. Mersch also viewed the situation as unpredictable. "What is important is that we do not have preconceived views, that we focus on the mandate, and that is what counts." The ECB's mandate is to maintain stable prices, which it defines as an inflation rate of less than two percent. Mersch, who is also governor of Luxembourg's central bank, said policy makers needed hard data as well as survey results to assess how much damage the economy had suffered as a consequence of the war. He said he would be looking closely at real interest rates of indexed bonds to see if medium-term inflation expectations had increased.
Mersch noted that private sector credit growth had been stable at a satisfactory level in recent months and that banks were working to bring their balance sheets into a healthier state. "We cannot speak of a credit crunch," he said. A cut in ECB rates would probably not lead to an increase in lending, he added. "Investors are not waiting for lower interest rates ... There are other elements determining investment decisions." The economy does need cash to regain its footing on the path to growth, but there was already plenty of it around, Mersch said. "Now liquidity is extremely ample. Not just in the euro zone but also in the United States." Mersch added he did not believe the euro zone was at risk of slipping into recession. He said the euro area would not return to its potential growth rate of 2.0-2.5 percent until 2004.//