Interest Rates Up in Europe

In the March 8th online edition of Business Week, Moore reported that the European Central Bank raised its interest rate by .25% to 3.75% in order to keep inflation at bay. This move was heavily criticized, however, since the overall inflation rate was less than the ECB’s recommended 2% for the last six months. Many, including the Association of European Chambers of Commerce, felt the interest raise was unnecessary and would discourage business growth in the coming quarters within the 13 European Countries that use the Euro. (Moore, 2007)

The European Central Bank is the European equivalent of the Federal Reserve Bank in the United States. By raising the interest rate by .25%, the ECB is affecting the discount rate, or the rate at which European banks can borrow money from the ECB. A higher interest rate means banks will have to pay more to borrow money, and will cause a decrease in the amount of money borrowed. In turn, banks will have less money to give investors, and the amount of people investing - starting new businesses, etc. - will drop. This is exactly why groups such as the Association of European Chambers of Commerce looks unfavorably upon the higher interest rates.

On the other hand, higher interest rates help to keep inflation down because there is less money supplied to the economy. As the quantity theory of money states; the more money in circulation, the higher prices will be for goods and services, which leads to inflation.

When the European Union was first formed, the ECB lowered interest rates to stimulate the growth and development of the new, larger economy. Now that the EU’s economy is relatively stable and healthy, the ECB believes higher interest rates will not have a substantial negative effect on the EU’s continued growth in the near future.

Even with the recent rise in interest rates, the ECBs rate at 3.75% is still lower than the Fed’s rate of 5.25%.

Source: Moore, Matt. “European Central Bank Raises Rates.” Business Week Online. March 8, 2007.
Reference URL: http://www.businessweek.com/ap/financialnews/D8NO6L000.htm?chan=search