Playing chicken in times of turbulence: M3 overshooting and the ECB monetary stance. EUMA Papers, Vol.4, No. 23 November 2007

This summer subprime crisis and the subsequent credit crunch have placed central banks again on the spot. In the USA and Europe, central banks have made significant steps to calm down financial turbulence by engineering liquidity injections, and interest rate shift. In Europe, following a recent Banking Lending Survey (October 2007) signaling a tightening of the credit standards for loans to enterprises, the ECB, in a counter-cyclical effort, has managed to leave on hold interest rate. As sound as sensible the ECB move can be seen, it appears the bank set to delay action on excess of liquidity, as shown in the persisting overshooting of M3. The ECB rates halt, or a likely near-term cut, as some would suggest, could only send the wrong signal. A neglect of M3 overshooting while accelerating inflationary pressures reveals the bank’s weakness in front of eurozone politicians claiming a more accommodative policy to offset the euro’s trend appreciation. In order to escape being entrapped into the rate dilemma, this paper suggests the bank has just to make a clear-cut choice: carry out the objective of cracking down on M3 overshooting, or hand over M3 quantitative target. If not, it will be seen playing chicken in the game.