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ECB’s Trichet Engineers His Economics

The day after the Federal Reserve’s emergency interest rate cut two weeks ago, Jean-Claude Trichet went before the European Parliament to deliver perhaps the most eagerly awaited speech of his four years as president of the European Central Bank.

It was a dense, technical presentation, packed with meaty thoughts on how Europe’s financial system could navigate the credit crisis spreading from the United States. But his audience cared about only one thing: Would Europe’s central bank follow the Fed’s cut?

The answer, which Mr. Trichet saved for the end of the talk, was no. Fighting inflation, he said, was still the bank’s cardinal goal — the “needle of our compass,” to use his well-worn phrase, which did not mean, of course, that the bank would never cut rates again.

It was a vintage performance by the world’s other most important central banker, showing off both Mr. Trichet’s cool-headed response to the market turmoil and his iron resolve that Europeans chart their own course in reacting to the troubles in the United States.

By comparison, bank watchers say, the Federal Reserve chairman, Ben S. Bernanke, has looked wobbly.

“In this situation, we’re lucky to have a genuine son of Brittany,” Alexandre Lamfalussy, former head of the European Monetary Institute, a forerunner to the central bank, said of the French-born Mr. Trichet. “Navigating in choppy waters is something a Breton knows well. He seems to like these conditions.”

But now, Mr. Trichet, 65, may be tacking into even heavier seas. If the United States tumbles into a recession, most experts agree, growth will slow across Europe, perhaps sharply. Some countries, like Ireland and Spain, already face a collapse in housing prices not unlike that in much of the United States.

And with inflation running well above the central bank’s threshold of 2 percent, Mr. Trichet fears that labor unions in Germany and elsewhere will use higher prices to extract big pay raises.

This danger has led Mr. Trichet to warn that the bank might actually raise, rather than cut, rates. Few economists expect the bank to make good on this threat, but some argue that it has put itself in a box, at a time when it needs all the flexibility it can get.

If all this is not enough, there are nagging questions about Europe’s own banks. Many have yet to disclose their full exposure to the subprime market, and experts say the risk of a banking crisis is more acute than it was last August, when the European Central Bank won praise for its timely injection of billions of euros into the financial system.

“We know there is a lot of toxic stuff in euro-zone banks,” said Adam Posen, the deputy director of the Peterson Institute for International Economics in Washington. “Up until now, the E.C.B. has had it easier than the Fed. Now they’re coming into a difficult period.”

Given the murkier outlook, some bank watchers expect Mr. Trichet to start laying the groundwork for a shift in policy Thursday, when the bank’s governing council holds its monthly meeting. Many economists predict that by summer, the bank will join the Fed in cutting rates.

The question is, Will that be soon enough for Europe to ward off the economic chill from the United States?

“They’re beginning to fall a little behind events,” said Thomas Mayer, the chief European economist at Deutsche Bank in London. “It seems to me they were more on the ball last summer.”

Mr. Mayer attributes this dichotomy, in part, to Mr. Trichet, whom he notes was trained as an engineer, rather than an economist like Mr. Bernanke or Mervyn A. King, the governor of the Bank of England.

“Trichet was very good when the banking system had a bout of indigestion,” Mr. Mayer said. “He intuitively realized there was a plumbing problem that needed to be fixed. Bernanke was much slower in realizing this, while Mervyn King was worrying about moral hazard.”

The trouble, Mr. Mayer said, is that Mr. Trichet’s skills may be less suited to the next phase of the crisis, which will involve reading economic tea leaves and making bets on future events.

The engineer’s approach is ‘show me the facts; what is there to fix?’ ” Mr. Mayer said. “The economist says there are serious problems brewing; I have to do something about it now.”

Until now, adversity has been good for the European Central Bank and its president. Starting Aug. 9, when Mr. Trichet took the lead among central bankers in injecting money into the world financial system to prevent a credit paralysis, he has shown a steady hand.

Mr. Trichet orchestrated a $139 billion injection that analysts say helped head off a calamitous seizing up of the market. Since then, the bank has periodically pumped more cash into the system, often in tandem with the Federal Reserve. Analysts say Mr. Trichet has cultivated close ties to Mr. Bernanke.

The European Central Bank’s effective response was partly because of institutional advantages. At the time, it accepted a wider range of securities as collateral for cash than the Fed or the Bank of England, which allowed it to marshal more resources.

Still, the swift response was a milestone for the bank. It proved the mettle of a 10-year-old institution that critics once said would be hamstrung by the collective nature of its leadership.

Publicly, Mr. Trichet has become the undisputed face of the bank — a role, given his prominence at meetings like the World Economic Forum that he seems to savor.

Certainly, he was well prepared. Educated in an engineering school and later at the elite École Nationale d’Administration, he spent his entire career, before his current post, in the French civil service, rising to be governor of the Bank of France.

“Trichet is your classic énarque,” said Mr. Posen, using French shorthand for a civil servant trained at the École Nationale. “Tough, politically savvy, reluctant to give up power.”

The question, he said, is whether Mr. Trichet will be able to keep control, especially if more banks get into trouble. If that happens, he said, the pressure from political leaders will be intense.

Absent such a crisis, however, Mr. Posen said he would not quibble with the bank’s focus on inflation. With Europeans recoiling at the price of bread and milk inflation is a real threat.

“The E.C.B. has a genuinely difficult call,” he said. “Growth is slowing down, but there is uncertainty about how quickly it is slowing down, or how much.”

Mr. Trichet has not yet offered detailed remedies for the crisis. In his remarks to the European Parliament, he called on banks to scrutinize their risk management policies. He also questioned the system of incentives involving originators of loans, banks that package them with other securities, and agencies that rate them.

“He knows there have to be reforms, but he doesn’t want to hurry it, and he’s right,” Mr. Lamfalussy said.

Mr. Trichet’s travel schedule, however, is so hectic that people inside the bank marvel at his stamina. On Monday, he was in Mumbai, India, for a meeting before returning to Frankfurt.

“He’s energized by the situation,” said Philip Lane, the director of the Institute for International Integration Studies at Trinity College, Dublin, who was recently in a meeting with him. “The E.C.B. and President Trichet are generally confident that they’ve done a good job.”

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