The European Central Bank (ECB) will announce its future monetary policy course on Thursday. At the meeting, the Governing Council faces high inflation of 7.5 percent, which suggests a rate hike.
On the other hand, the war in Ukraine is raising concerns about the economy, which speaks for a continuation of the loose monetary policy. Central banks faced similar contradictions in the 1970s. It is now important that the ECB draws the right lessons from the mistakes made at the time.
Economic policy in the 1970s was characterized by Keynesianism. This school of thought wants to avoid recessions and ensure low unemployment through economic stimulus programs and an expansive monetary policy.
Western governments stuck to this demand policy even after the oil price shock of 1973, although the West had to deliver more goods to the oil-producing countries in exchange for more expensive energy and overall economic supply fell. Government-boosted demand met reduced supply due to oil prices, fueling inflation.
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The fact that inflation remained so high long after the oil price shock was due to the central banks, which allowed themselves to be harnessed by the governments and allowed the money supply to grow too much.
lessons of the 1970s
This took on almost grotesque features in the USA. Arthur Burns, who chaired the US Federal Reserve from 1970 to 1978, allowed himself to be co-opted by former President Richard Nixon. The tapes from the White House that have since been released show that the President repeatedly called for high growth in the money supply and low key interest rates in order to increase his chances of re-election.
At the same time, he baited his central bank governor by offering to meet him anytime, poking fun at the “myth of an independent central bank” in his presence.
The Bundesbank self-confidently defended its independence in the 1970s, which is why inflation in Germany was not as high as in the USA. But the Bundesbank’s annual reports at the time show that it, too, was considerate of the federal government, which wanted to boost the economy with economic stimulus packages. The Bundesbank has more than once excused exceeding its money supply target with the wish to boost the economy despite high inflation.
The 1970s taught us how dangerous it is when central banks do not focus on maintaining price stability, but allow themselves to be enlisted by governments to achieve their goals.
In this respect, it is worrying that the ECB is particularly eyeing the southern member countries, which want low interest rates in order to be able to service their high debts more easily. This so-called fiscal dominance gives reason to fear persistently high inflation for the coming years.
More: ECB minutes – currency watchdogs fear stagflation.