The problems with not being able to control your country’s monetary policy become clearest during the bust, but as the chart above (courtesy of Edward Hugh) illustrates they exist during the boom as well. What we’re looking at is the Spanish inflation rate versus the European Central Bank’s policy rate. During all those years—2002, 2003, 2004, 2005, 2006—when the yellow area was poking above the blue area, real rates in Spain were negative.
There’s nothing wrong with negative real interest rates as a tool to revive a deeply depressed economy. In fact, America could use such rates right now. But Spain wasn’t a deeply depressed economy at the time. So it got a very distortionary building boom. Not because the European Central Bank was deliberately trying to do this, but because the ECB is basically targeting conditions in Germany. The German economy was, at the time, fairly depressed and the loose money and high inflation in the periphery helped bolster German employment and increase the competitiveness of its exports. But now that Spain does need loose money the ECB’s not delivering it because policy that would help Spain would be highly inflationary in Germany.