The European Central Bank, as expected, raised interest rates a quarter point to 4.25% in a bid to attack inflation despite signs of weakening growth. The U.S. Federal Reserve, meanwhile, appears to be on hold for the coming months — despite rising inflation concerns — to give the economy more time to recover from the turmoil in housing, credit, labor and energy markets. Their divergence might be explained by the central banks’ mandates: the ECB is charged with maintaining price stability first, while the Fed aims to achieve low inflation and optimal growth at the same time.

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But the difference in mandates or even economic circumstances between the U.S. and Europe don’t quite account for the divide, Deutsche Bank economists say in a research note this week titled “ECB is from Mars and Fed is from Venus.” As chief economist Peter Hooper explains, “The two central banks are reacting to relatively similar economic and financial circumstances as if they are from different planets, with the ECB’s approach akin to a frontal attack on inflation that the Roman god Mars would have approved of, while the Fed is being more cautious and patient, in a manner the goddess Venus would have endorsed.”

The Deutsche Bank economists say the divergence comes from the two regions’ different historical experiences in dealing with the shock from deflating asset prices and rising inflation.

In the United States: “The traumatic experience of the deflation and extreme levels of unemployment that occurred during the Great Depression in the 1930s – and the Fed’s mistakes during this period — play a prominent role in the discussion of monetary policy by both practitioners and academics. Accordingly, Fed policy makers have been very sensitive to the risk of asset price collapses and debt deflation (note, for example, the Fed’s reaction to the 1987 stock market crash, the [Long-Term Capital Management] crisis, and the burst of the dot-com bubble).”

In Europe: “Probably the most prominent economic trauma in Europe were Germany’s hyperinflation after World War I and currency reform after World War II. Throughout its existence the Bundesbank was extremely sensitive to inflation pressures, and willing to take significant risks with growth to keep inflation in check (note, for example, the Bundesbank’s reaction to the two oil shocks of the 1970s and its reluctance to follow the Fed in 1987). German sensitivity to inflation risks of course had a strong influence on the institutional design of the ECB and more recently on the implementation of the euro zone’s monetary policy.”

Of course, Fed officials in recent weeks have ratcheted up their talk about “vigilance” of inflation and inflation expectations. But most policy makers appear inclined to wait as long as they can to give their rate cuts of the last year a chance to work. And the ECB won’t necessarily be following today’s rate increase with more tightening. The Deutsche Bank economists say the the transatlantic policy divergence will diminish when weaker growth in Europe lowers fears at the ECB and even leads to rate cuts in 2009, while the Fed remains on hold. “What now looks like the beginning of a new transatlantic divergence of monetary policy,” they write, “will in our view eventually look like a blip in the time-tested relationship of the Fed leading and European central banks following.” - Sudeep Reddy