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Monetary policy

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In the U.S., some people can't imagine how the Federal Reserve could even think about tightening monetary policy with 8.8 percent of the workforce unemployed.

To stimulate the imagination, one needs only to look at Europe. The European Central Bank raised its key interest rate last week for the first time in nearly three years, even though unemployment stands at 9.9 percent in the 17-nation euro zone. U.S. central bank officials have dropped only the faintest hints that they eventually need to push rates higher, and most observers don't think that will happen until next year.

For an American audience, then, Axel Weber's speech Wednesday in St. Louis was an interesting preview of what we can expect to hear sooner or later from our own central bankers. Weber, the president of Germany's Bundesbank, gave the annual Homer Jones lecture at the Federal Reserve Bank of St. Louis.

In a news conference before the speech, Weber emphasized that one small boost in interest rates — from 1 to 1.25 percent — won't be enough. "Even after the 25 basis point hike, monetary policy in Europe is still very accommodative," he said. "With the economy doing much better and financial markets improving … if these trends continue, then further tightening is appropriate."

Weber also warned banks that they'll soon lose access to cheap financing that the ECB has been providing through special lines of credit. "This is a crisis measure, and like all crisis measures, they have to be transitory," he said.

He concluded his speech with a warning to free-spending government officials: "The current era of low interest rates will come to an end, and unfortunately, the more fiscal policy gets out of hand, the sooner it will come to an end."

As Bundesbank president, a post he's leaving at the end of this month, Weber sits on the governing council of the European Central Bank. The ECB must deal with 17 sovereign governments, including three that have asked for bailouts. So we shouldn't be as surprised at his call for fiscal sanity as we would be if, say, a Federal Reserve Board member started lecturing Congress on deficit spending.

Still, it's worth thinking about whether, and when, the U.S. needs to hear a similar message. James Bullard, president of the St. Louis Fed, has been saying that it's time for the Fed to talk about an exit from the extraordinary measures it has taken since the 2008 financial crisis. Those measures include near-zero interest rates and two rounds of securities purchases known as quantitative easing.

"We have to think about how we will exit from this policy in a way that keeps inflation low and stable," Bullard told reporters before Weber's speech.

He noted that the economy is stronger, and inflation higher, than it was last fall when the Fed launched its latest round of quantitative easing, called QE2. Bullard argues that QE2 should be scaled back, but he admitted that "there's not a groundswell of support for that view" within the Fed.

Outside the Fed, there are folks who think monetary policy isn't easy enough. Christina Romer, former chair of President Barack Obama's Council of Economic Advisers, said Tuesday that she'd like to see the Fed "continuing and indeed expanding the current round of quantitative easing."

Romer, unlike Bullard, doesn't attend the Fed's policy meetings. Bullard's Fed colleagues are more likely to come round to his view than to hers, and when they do, we should listen for the echoes from Europe.

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