April 27, 2009 / 6:58 PM / in 10 years

UPDATE 1-ECB's Trichet: Lowering rates not always best path

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NEW YORK, April 27 (Reuters) - Lowering interest rates is not necessarily the best way to fight a recession and differing economic structures mean policy effectiveness varies, European Central Bank President Jean-Claude Trichet said on Monday.

“Monetary policy is the more effective in response to a downturn, the argument goes, the lower the policy rate. This view is too simplistic,” Trichet told a Foreign Policy Association lunch in New York.

“Comparing only the levels of policy rates without consideration of the resulting market rates and other economic variables is looking at just one part of a far broader canvas,” Trichet said.

In his speech, Trichet defended the ECB’s reaction to the crisis, which some analysts have criticized as being too slow compared to that of other central banks, such as the U.S. Federal Reserve.

The ECB raised interest rates to 4.25 percent in mid-2008 but has since cut benchmark credit costs to 1.25 percent.

Meanwhile, the Fed has slashed rates to a zero to 0.25 percent range.

“Our actions have been different from those taken by other central banks, reflecting differences in economic and financial structures. Indeed, given the different economic structures, they need to be different to reach the same objective,” Trichet said.

He said “overly activist policies” risk being counterproductive in the euro area as they can destabilize private sector expectations in an environment in which fiscal and monetary policy is geared towards fiscal sustainability and price stability.

Another way the euro area differs from the United States is the importance of the banking sector, Trichet said. At the end of 2007, the stock of outstanding bank loans to the private sector amounted to around 145 percent of gross domestic product, compared to 63 percent in the United States.

This means “that to be effective, ECB policy must focus first and foremost on the banking sector,” Trichet said.

Trichet said that addressing the problem of bad loans, or toxic assets, is crucial to reviving credit. But he said the problem “clearly falls into the realm of fiscal policy, not monetary policy.”

Inflation expectations have been “exceptionally resistant” to sudden short-term price changes, Trichet said, adding that even in the face of sharply falling inflation the ECB will ensure that expectations remain stable.

While risks remain of “a sudden emergence of unexpected financial turbulence,” the ECB has to balance the need to take immediate action to combat the financial crisis and its obligation to return to a sustainable path in the medium term, Trichet said. (Reporting by Kristina Cooke and Anna Willard; Editing by Kenneth Barry)

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