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ECB tower in Frankfurt am Main: Not the only central bank that has underestimated inflation
Photo:
Frank Rumpenhorst / dpa
Not so long ago, leaders of the European Central Bank (ECB) publicly complained about overly critical reporting.
Journalists would paint the "specter of inflation" on the wall, ECB Executive Board member Isabell Schnabel reported in the autumn : While the situation is tending to normalize, the media in Germany are stoking public fears without explaining the reasons behind the price movements to explain.
That was in September.
At that time, consumer prices in Germany were already increasing at a rate of 3.4 percent compared to the previous year.
But the price pressure will ease once the delivery bottlenecks caused by the pandemic have been overcome and the special statistical effect from the temporary reduction in VAT no longer applies - that was the central bankers' standard story: everything "temporarily", everything under control.
Schnabel recently gave another interview and told the Handelsblatt newspaper that she thought inflation was "extremely high".
Prices have recently risen at an annual rate of 7.5 percent.
Not only energy and food are becoming more expensive, the price dynamics have long since spread to goods and services.
Surveys show that citizens now expect permanently higher inflation rates.
Trade unions such as IG Metall are logically demanding a wage supplement of more than eight percent.
Those second-round effects that make inflation a sure-fire success that is difficult to catch again have long been apparent.
Schnabel is combative: Talking is no longer enough, "we have to act".
However, I fear that it is now too late to quickly regain price momentum.
We may have to brace ourselves for a long inflationary phase.
Central bank errors
Of course, the ECB was not the only central bank to underestimate inflation.
The US Federal Reserve Bank and the Bank of England were similarly far off the mark.
Nonetheless, these collective errors are remarkable.
Because you really didn't have to be a prophet to recognize the danger of a surge in inflation after the corona pandemic abated.
That the gigantic crisis programs of the central banks and governments would come up against an economy whose production possibilities would be narrower after the pandemic, that the central banks would then have to step on the brakes vigorously - we first discussed it here in March 2020, and then again and again .
more on the subject
Fight against wave of inflation: Bank of England raises interest rates
A year ago, Larry Summers, former US Treasury Secretary under Bill Clinton, spoke of the scenario of excessive inflation in the US and a subsequent crash on the financial markets because at some point interest rates would have to rise rapidly and violently.
Summers pretty much predicted what appears to be going on in the stock markets right now.
And what did the ECB do?
She had the option of capturing inflation expectations at an early stage, designing a concrete exit scenario from the crisis programs, initiating and communicating the first steps towards tightening monetary policy - such as an end to "negative deposit rates", those penalties on central bank deposits that weaken banks in the long term.
Instead, the central bankers announced that everything was on the right track.
No reason to worry.
The stable money story grew wilder as the facts strayed from it.
The supposed certainty that price stability was guaranteed in the medium term and that interest rates would remain low determined action.
The ECB was not alone in this stance, the US Federal Reserve was further wrong.
But that doesn't make things any better.
turning point in the world economy
The carelessness with which the central banks allowed inflation to run its course last year is based on previous experience.
Since the financial crisis of 2008, the ECB, Fed & Co. have been able to pump practically as much money into the economy as they want without inflation rising significantly.
The open, globalized economy ensured an almost infinitely flexible supply, no matter how much liquid funds poured into the markets.
It has been clear for some time that this era is coming to an end: Donald Trump's trade war and Great Britain's exit from the EU already indicated a fragmentation of the world markets.
The Covid 19 shock did the rest because it revealed how fragile the international production links are - and that companies should better buy some products locally, even if it's more expensive.
The pandemic has triggered shifts in economic structures.
The era of the highly flexible supply of goods is coming to an end.
All of this has been observed for a long time.
From late last summer, inflation actually picked up measurably.
At that point, at the latest, it would have been high time to gradually take countermeasures.
But the central bankers missed the right moment and instead tried to moderate the rise in prices.
That went wrong.
Since the beginning of the year at the latest, it has been obvious that inflation is not passing by like a few dark clouds from which no rain falls in the end.
Now, however, we Europeans are stuck in a completely different scenario.
And that makes it even harder to contain inflation.
central banks as a deterrent
Since February 24, the ECB has been a central bank at war.
While the EU is not directly involved in fighting in Ukraine, we are clearly on the side of Russia's war of aggression.
Boycotts and embargoes are on the way.
Russia, the world's largest energy exporter, is to be partially cut off from the world market.
This has massive economic implications.
The overall economic supply is restricted, energy and other raw materials are becoming scarce and expensive.
Rising energy costs are also driving inflation dynamics.
A geopolitical shock is now hitting an economy already overstretched with liquidity.
In addition, the role of central banks changes during war.
Normally they are primarily responsible for price and financial stability.
»In times of war«, on the other hand, »support for state financing« becomes the central task, as the British economist Charles Goodhart summarized in a historical review a few years ago.
Other goals of the central banks would have to take a back seat.
The central banks of England and France were once founded to help finance wars.
Britain's rise to prominence in the 18th and 19th centuries would not have been possible without the support of the Bank of England.
Money is perhaps the ultimate resource in war: a state that runs out of funds mid-fight has already lost.
This is precisely why Vladimir Putin has been trimming his country for maximum financial resilience for years.
In concrete terms, this means in the present: The ECB now has to ensure that no euro state goes bankrupt.
Seen in this way, it is part of Western deterrence.
Roman promissory notes
The most delicate case is Italy.
The country is pushing a mountain of debt of 2.7 trillion euros, significantly higher than Germany's.
The Italian economy has long suffered from anemic growth and a shrinking population.
Dependence on Russian gas imports makes a recession likely in the event of a supply freeze, further threatening debt sustainability.
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The fact that the stock exchanges are keeping a very close eye on Italy's state finances is shown by the interest rate difference compared to German government bonds: Because investors fear that Roman promissory notes are associated with a higher risk of bankruptcy, the "spread" has recently increased noticeably again.
Should Italy's credibility continue to suffer, a destructive momentum of its own could set in: rising interest rates could make the new debts necessary in the war much more expensive - and thus further undermine Italy's fiscal credibility.
What somewhat secures Rome's position is the structure of its liabilities: more than two-thirds of its outstanding debt has long-term fixed interest rates or is held by the central bank.
Only a third is subject to the risk of rapidly rising interest and inflation rates, as the International Monetary Fund (IMF) has just calculated.
The EU Corona aid fund, from which Italy receives almost 200 billion euros, also helps.
This allows public investments to be financed without directly burdening Italy's state budget and without the finance minister having to raise money on the capital market.
The central banker's dilemma
The dilemma in which the ECB is now can be seen in Italy.
The mountain of debt is so large that ultimately it can only be credibly secured by the central bank.
The funds from the ESM euro bailout fund, which could be converted into a “stability fund” in the future, are not sufficient for this.
Other euro countries face similar problems, but Italy is the most complicated case because of its size.
Rising interest rates make government borrowing more expensive.
If the ECB were to slam on the brakes hard to dampen price momentum, and possibly even start throwing bonds it owns back onto the market (»quantitative tightening«), this could massively weaken debt sustainability.
NATO states that are on the brink of bankruptcy in the conflict with Russia would be a fiasco in terms of security policy.
It must not come to that.
Inflation, on the other hand, eases the burdens of heavily indebted countries over the years, especially if their outstanding debt has a fixed interest rate.
If the ECB moves slowly, raising interest rates very gradually and buying bonds from time to time to limit spread widening, it could help to “support public finance”.
Inflation might settle at a higher level than usual, perhaps five or seven percent instead of under two percent.
Can we stand it?
Inflation is a burden that hits the poorer sections of the population hard, especially when the economy is hardly growing.
Currency devaluation endangers social and political stability in the West, as the strong performance of the right-wing populists in the French elections recently underlined.
There are no easy ways out.
And the longer the conflict with Russia lasts, the more difficult the trade-off between monetary stability and state finances becomes.
The central banker's job has become extremely demanding.
If they had taken countermeasures earlier, they would now have a credibility bonus, after all.
But the situation would be difficult one way or the other.
There are ghosts that have come to stay.
The most important dates of the coming week
Expand areaMonday
Kiel/Berlin –
Review
– Result summary after the state election in Schleswig-Holstein.
Beijing –
globalization in reverse?
– China's customs release new figures on foreign trade.
Group results I
– business figures from Biontech, Infineon, Hochtief, PostNL.
ExpandareaTuesday
Luxembourg -
Germany vs. Zuckerberg
- Oral hearing before the European Court of Justice in the dispute between the Facebook parent company Meta and the Federal Cartel Office.
The question is whether the company is abusing a dominant position by merging user data from different platforms.
Group results II
– Business figures from Munich Re, Bayer, Schaeffler, Siltronic, Aurubis, Dürr, Endesa, Pirelli, Sony, Warner Music, Diebold Nixdorf.
ExpandareaWednesday
Group results III
– Business figures from Continental, KfW, Tui, Bilfinger, Jenoptik, Siemens Energy.
Beijing -
Sweet and sour inflation
- China's statistical office announces the latest price developments in the country.
Expand areaThursday
Group results IV
– Business figures from Allianz, Siemens, Merck, Commerzbank, Knorr Bremse, Bechtle, Sixt, ProSiebenSat.1
ExpandareaFriday
Stuttgart –
Feed the World
– Start of G7 meeting of agriculture ministers chaired by Agriculture Minister Özdemir.
It is primarily about the food crisis as a result of the Ukraine war.
Group results V
– business figures from Carl Zeiss Meditec, EnBW, Grenke.
Expand areaSunday
Düsseldorf –
Germany's next Laschet
– state elections in North Rhine-Westphalia.
