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Sunday, 10 November, 2002, 09:52 GMT
French back ECB reform
ECB president Wim Duisenberg
ECB president Wim Duisenberg steps down soon

The French Government is preparing to back proposals for a fundamental reform of the European Central Bank (ECB).

The changes would make the ECB's cumbersome decision-making process easier, allowing it to move more quickly to cut interest rates.

And it would change the way the ECB targets inflation, removing another obstacle to rate cuts.

Last week the ECB kept interest rates unchanged at 3.25% for the eleventh month in a row, despite the sharp deterioration of the German economy and a big rate cut in the United States.

Hopes for UK

If implemented, the reforms would allay many of the fears expressed by the UK Chancellor, Gordon Brown, and make it easier for Britain eventually to join the eurozone.

The French position is crucial because a Frenchman, Jean-Claude Trichet, is widely expected to become the new head of the ECB in July, when current president Wim Duisenberg steps down.

The changes are being proposed by the French Council of Economic Advisors, reporting directly to the Prime Minister, Jean Pierre Raffarin, who is believed to be strongly backing the reforms.

In their proposal, economists Charles Wyplosz and Patrick Artus, argue that the ECB should replace its confusing "two pillar" inflation target - including complex calculations of monetary targets which have been largely abandoned elsewhere - with a broad numerical target, aimed at keeping inflation in a range of 1-4% (compared with the current target of 2% or under).


They also say that the ECB's board - which already comprises the 12 central bank chiefs from all the countries of the eurozone - will become completely unwieldy after enlargement, when another 10 counties will eventually join.

They suggest instead a small monetary policy committee, like that of the Bank of England, which has operational responsibility for setting interest rates to meet the target.

They are also believed to argue, that like the Bank of England, the target should be symmetrical - allowing the Bank leeway to cut rates further if it fears that prices are dropping too low and there is a danger of deflation.

Struggle over growth pact

Meanwhile, the ECB is engaged in a bitter struggle with the German Government over the Stability and Growth Pact.

Germany, which insisted on introducing a coda when the euro was introduced forcing countries to stick to strict Budget limits, is now itself likely to break that limit.

The German economy is likely to show virtually no growth this year, and less than 1% next year, according to the five leading German think tanks in a report to be released on Monday.

And the German Budget deficit is expected to rise to 3.7%, well above the 3% limit in the Stability Pact.

As a consequence, Germany could in theory face fines imposed by other EU finance ministers of up to 5% of GDP for breaching the target.

The German government, and many economists, believe that the Growth and Stability Pact is too rigid and should be revised to take more account of the fact that deficits always rise during recessions.

But the ECB, and many smaller eurozone members, are adamantly opposed.

They fear that without the simple rule in the Stability Pact, there would be no way of coordinating monetary and fiscal policy in the eurozone, and inflation would eventually run rampant as countries printed money to counteract any tough decisions on interest rates.

The deadlock is the main reason that the ECB is refusing to cut interest rates.

There are some signs, however, that the larger eurozone countries - including France, Italy, and the Netherlands - are sympathetic to Germany's plight.

Indeed the French may want German support for their ECB reform plan as a quid pro quo in return for backing any changes to the Stability Pact.

Changing the Stability Pact, however, will be even more difficult than changing the make-up of the ECB.

Both will require possible treaty changes and arduous negotiations with member states - and neither will happen in time to influence what happens during the current economic slowdown.

Until both these issues are resolved, Gordon Brown will have good reason to delay any plans for UK membership of the euro.

The BBC's Davis Peers
"The European Central Bank is mandated to fight inflation first and foremost"
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