Central bank criticism: is the ECB underestimating inflation?

To analyse

As of: 10/28/2021 6:24 a.m.

The European Central Bank considers the high inflation rates to be temporary and sees no need for action. The criticism of this point of view is getting louder and louder. Does the ECB misjudge the situation?

An analysis by Klaus-Rainer Jackisch, HR

There was a special relationship between Chancellor Angela Merkel and Bundesbank President Jens Weidmann. The head of government had so much trust in her economic advisor at the time that she left the room during a meeting with journalists – with the hint that Weidmann would answer the questions in her favor. Merkel later made the then 44-year-old head of the Bundesbank, where he enjoyed great respect.

Klaus-Rainer Jackisch

It would have been logical if Merkel had helped Weidmann to the office of President of the European Central Bank – a position that should go to a German after Mario Draghi left. But Merkel decided to work to ensure that Ursula von der Leyen received the head of the EU Commission. In return, the executive chair at the ECB became a pawn sacrifice and thus Weidmann’s ambitions. In the end, the French Christine Lagarde moved into the Frankfurt Eurotower in his place.

The frustration of the “hawk”

Weidmann never really got over this defeat and it weakened his position in the Governing Council. The eternal warning against the consequences of the ultra-loose monetary policy was the epitome of the “hawks” in the body, who are skeptical of bond purchases and the zero interest rate policy.

Weidmann was ready to take on Draghi on these issues. He accepted that he was in the minority on the Governing Council. He had to watch how the ECB’s construct, conceived by its founders based on the Bundesbank model, gradually changed. Weidmann took one slap after the other – until last week the barrel apparently overflowed. Because it became increasingly clear that two of the three partners in the possible traffic light coalition are not very inclined to support Weidmann’s hard line. The 54-year-old Bundesbank president threw in the towel and surprisingly announced his departure at the end of the year.

Price stability must be a priority for the ECB

The Bundesbanker’s frustration is a reflection of the changes within the ECB, which are also reflected in the attitude towards inflation developments. Keeping prices in check is the central task of the ECB. The statutes clearly state that guaranteeing price stability must be the top priority of the monetary authorities. The ECB presidents have always bent and twisted to reconcile their measures with this primacy and to justify them. Not always convincing. But now more and more critics are asking whether the ECB still takes this goal seriously and feels sufficiently committed to this task.

Since the beginning of the year, the inflation rate has risen sharply in the euro area. Last December it was even negative at -0.3 percent. Then it soared to 3.4 percent by September. In Germany it is currently 4.1 percent and threatens to crack the five percent mark in November. Citizens pay significantly higher energy prices and have to dig deeper into their wallets to buy something in the supermarket or to fill up at the petrol pump.

ECB considers high inflation to be a temporary phenomenon

The majority of the Governing Council, above all President Christine Lagarde and Chief Economist Philip Lane, who is pulling the strings in the background, has been emphasizing for months that the sharp rise in prices is only of a temporary nature. According to this, the inflation rate has been driven up by special factors: These include the rapid economic recovery after the peak of the Corona crisis, the resulting distortions in the supply chains, the bottlenecks in goods and services and, in particular, the massive increases in raw material and energy prices. In Germany, the lowering of VAT rates and their return to the old level as well as the increased CO2 pricing are also having an impact.

According to the ECB, all these developments will work out again in the coming year at the latest. Then the rate of price increases will fall again. “We expect inflation to rise further this fall, but fall in the coming year,” said Lagarde in September. According to calculations by their economists, the inflation rate in the euro area is likely to rise to 2.2 percent this year, but decrease to 1.7 percent in the next and fall to 1.5 percent the following year. If these prognoses were to become reality, the ECB would not hit its self-imposed target of an inflation rate of exactly two percent with pinpoint accuracy, but overall it would be doing quite well.

ECB President Lagarde expects inflation to decline significantly in the coming year.

Image: EPA

In view of these assessments, all efforts to tighten the ultra-loose monetary policy have so far been rejected: the bond purchases will continue in the same amount in order to provide companies with liquidity. Interest rates stayed at zero percent. There is penalty interest for large deposits at the ECB. Because there is “still a certain way to go until the damage caused by the pandemic is repaired,” said Lagarde. For this reason, one wants to think about a possible expiry of the Corona aid program PEPP in December at the earliest. Then new inflation forecasts are available. In short: So far, the ECB sees no need for action.

Development in the countries very different

This is also due to the fact that the price increase rates in the 19 member states of the euro zone develop very differently: While the inflation rate is highest in Estonia and Lithuania at 6.4 percent and Germany is also one of the countries with the highest inflation at over four percent, the situation is completely different in parts of the south of the monetary union: In Portugal the inflation rate is only 1.3 percent, in Greece 1.9 percent. It is lowest in Malta at just 0.7 percent. The values ​​were seldom that far apart. However, every country has an equal voice in the Governing Council. Therefore, a consensus has to be found, which becomes more difficult the more the inflation rates diverge between the states.

Nevertheless, there is great criticism that the ECB is underestimating the current price surge and assessing the situation too optimistically. Jörg Krämer, chief economist at Commerzbank, believes that “inflation will continue to rise in the coming months”. Like his colleague Carsten Brzeski, Chief Economist Germany at ING Bank, he also assumes that the price trend will weaken somewhat in the next year. “Nevertheless, the inflation rate will not go down as much as it did before the Corona crisis,” Brzeski said in an interview with ARD finance department.

Professor Friedrich Heinemann, economist at the Center for European Economic Research (ZEW), is even more critical. He fears that the development could trigger “permanent price pressure” because the pandemic has also changed the structures of the world economy: There is an increasing shortage of workers, China is saying goodbye as a low-wage country and more and more companies in this country want to escape the delivery bottlenecks by doing so Increased production of primary products in Europe and Germany again. But that is more expensive and should keep prices high in the long term. He had “growing doubts, especially at the ECB,” that the monetary authorities “are still resolutely acting against it,” said Heinemann in an interview with “Welt”. “I believe that many on the ECB’s Board of Management and Council are praying that inflationary pressures will not become permanent.”

High national debt as a problem

They are probably also doing this because the monetary authorities would get into a dilemma if inflation solidified. In recent years, in addition to the primacy of price stability, the ECB has also had another important goal that would never officially be admitted: consideration for the heavily indebted national budgets, especially in southern European countries. The corona crisis has significantly exacerbated the situation there: In Spain, for example, the national debt measured in terms of gross domestic product rose from around 95 to around 125 percent due to the collapse in the important tourism sector. In Greece it is still the highest at just under 210 percent, followed by Italy with 160 percent.

If the aid granted by the ECB in the form of bond purchases were withdrawn too quickly, and if interest rates even rose again, these countries would have considerable problems in obtaining fresh money on the financial markets. A new euro crisis could not be ruled out.

Many critics see these considerations as the real reason for the ECB’s reluctance to act in the face of rising prices. It also explains why the ECB’s assessment is so different from that of other central banks in the world, where inflation rates have also risen significantly. Because in Canada, Great Britain, Sweden and also in the USA the tightening of monetary policy has long been initiated or announced.

These considerations are corroborated by the research results of the ZEW. A study has shown that the advocates of the loose monetary policy in the Governing Council mainly come from the heavily indebted countries, while the less clammy countries are more likely to see the dangers of inflation. “The respective fiscal interests play a role at least subliminally,” said study leader Heinemann.

Weidmann’s resignation weakens supporters of tight monetary policy

This is exactly where we come full circle to Jens Weidmann. He also saw the danger that the ECB would primarily concern itself with the welfare of the southern states and thus the weal and woe of the common currency as a whole, instead of following the primacy of price stability – even if he only ever did so as part of the Governing Council could express diplomatically and never so directly. His resignation as President of the Bundesbank weakens the position of the hawks in this respect as well. This does not bode well for consumers: they will have to pay higher prices in the future for the welfare of the monetary union.


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