ECB chief says more flexible labor rules will facilitate interest rate cuts

COLOGNE (Reuters) – Substantial reforms to product and labor markets would lessen inflationary pressures in the eurozone and make decisions on interest rates easier, European Central Bank (ECB) President Jean-Claude Trichet said yesterday. Under pressure from Europe’s largest countries to do more to boost growth, Trichet held out the carrot that government action to speed up structural reforms to make their economies more competitive would give the ECB some leeway to provide cheaper credit. «One notable consequence of reforms would be to lower inflation persistence,» Trichet said in a speech on supply side economics and monetary policy before the Institute for the German Economy. If labor markets are more flexible, supply shocks, such as a sharp rise in oil prices, would be easier to absorb. Upward pressure on wages would be less, thus limiting so-called second-round inflationary impact from oil, he said. «This in turn would allow monetary policy to react less strongly to such shocks,» he said. «A flexible… environment will make it easier for monetary policy to maintain price stability, while at the same time, it should also help to keep volatility of output and unemployment lower,» the ECB president said. His speech amounted to a rebuttal of politicians’ renewed criticism of the ECB for turning a deaf ear to growth and for focusing too much on inflation, hours after Finland’s acting central bank governor Matti Louekoski blasted politicians for trying to exert control over the ECB. Louekoski told Reuters in an interview that politicians should first «look in the mirror and see what sort of economic policy their own governments’ exercise.» Trichet said that the best contribution the ECB can make to growth and job creation is to maintain price stability and anchor long-term inflation expectations at low and stable levels. Indeed Louekoski said that the central bank had discussed extensively cutting ECB rates, already at historic lows of 2.00 percent, but opted to ensure its price stability goal was met. «The ECB’s monetary policy has been very accommodating, and there is reason for asking whether (even) lower rates would have helped more than the present consistent and light monetary policy,» Louekoski told Reuters. For their part, Trichet said that European Union governments can boost the region’s growth potential through further economic reforms, he said. «The high rate of unemployment in the euro area, which unfortunately amounted to 8.9 percent in 2003, signals the very, very insufficient flexibility of the euro area,» he said. «Thus, there is a necessity to make further substantial efforts on structural reforms in labor markets in particular,» he said, citing the higher growth rates enjoyed by Ireland and the Netherlands after they removed market controls.