The Bank's Baby Steps.(European Central Bank)

The hottest debate in economic circles right now is whether the United States or Germany will soon be crippled, like Japan, by falling prices. Listening to U.S. Federal Reserve chief Alan Greenspan deliver a sermon on the perils of deflation in Berlin last week, Wim Duisenberg seemed "uncomfortable," says one economist who makes a living analyzing the European Central Bank president's every move. Duisenberg later made his stand plain: "We don't see deflation coming."

But deep inside the Eurotower, headquarters of the ECB, a recent strategy review implies that Duisenberg may be more concerned than he is willing to let on. The inflation target for the bank used to be zero to 2 percent, but now it is "close to, but below" 2, implying the need to steer further clear of falling prices. And when the bank considers a change in interest rates, it used to look first at the supply of money, then at the general conditions of the economy. Now it has reversed the order. Announced without fanfare on May 8, these changes made it easier for the ECB to justify cutting interest rates last Thursday by a rather strong half a point to 2.0 percent. "In the obscure world of central banking, this is progress," says Allan Saunderson, a monetary-policy expert at EuroZone Advisors in Frankfurt.

The ECB is only five years old. It is eager to build up credibility, and loath to admit that it might have been shooting at the wrong targets. By focusing on the money supply, the ECB tends to react slowly to the ripple effect of larger events, like the tanking of the U.S. economy in early 2001. It is also extremely difficult to use the money supply to fine-tune growth, which is why the United States abandoned that approach in the 1980s. The ECB policy, on the other hand, continued to mimic that of Germany's Bundesbank and its obsession with inflation. The ...