So far these Kassandren have rather embarrassed themselves with it. But in October 2021, German inflation soared to 4.5 percent. In November there could even be a five before the decimal point. Are we now threatened with the big end, a sustained decline in the value of our money as a result of an allegedly wrong monetary policy? The answer is no. The current inflation is primarily an outlier caused by the pandemic.
It has little to do with monetary policy. Unless oil prices rise immeasurably, inflation will noticeably decrease again in 2022. Nevertheless, the ECB now has to be careful. Because the situation is changing. What was right in the first corona wave in March 2020 is hardly appropriate today. At the latest when the fourth wave of the pandemic subsides, the ECB should initiate the turnaround in monetary policy.
Let us first take a look at the current situation. To measure inflation, our statisticians compare today’s prices with those of the previous year. The year-on-year price increase is particularly high if either the goods and services are extraordinarily expensive today – or if they were particularly cheap a year ago.
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The second effect currently predominates. More than half of the German inflation rate of 4.5 percent expresses that many prices were very low in the last autumn of the pandemic. For example, the German value added tax, which was temporarily lowered by three points in the second half of 2020, depressed the local price level by around 1.2 percent. In order to deduct these and other special effects, it is advisable to compare the current prices with those before the pandemic.
No reason to panic
Relative to October 2019 instead of October 2020, there is an average increase in German consumer prices of two percent per year. For the euro zone, this rate is 1.9 percent. So no need to panic. In addition, especially the volatile energy prices after the unprecedented slump in 2020 this autumn shot far above their long-term justified level.
Oil and gas are expensive. Without energy, the two-year rate of inflation, i.e. the annual comparison with the prices before the pandemic, reached just 1.6 percent in Germany and 1.3 percent in the euro zone in October. These figures reflect the real inflationary pressures that the ECB can influence over the long term with its monetary policy.
The one-off inflation-driving effects will drop out of the previous year’s comparison of consumer prices in the course of 2022. Delivery bottlenecks should ease somewhat, logistics costs can drop slightly when the pre-Christmas high season is over and the warehouses have filled up again. Unless energy prices explode again, euro inflation, measured in the usual way, could fall below two percent again in autumn 2022 compared to the previous year.
But that does not mean that the “pigeons” in the ECB are absolutely right. They use this outlook as an argument to maintain the aggressive monetary policy with high bond purchases and low interest rates for as long as possible. In doing so, they overlook the fact that the actual reason for the ECB’s deployment of the Corona crisis has already ceased to exist. The virus claims many victims again, especially in Germany and other countries with comparatively low vaccination rates. But it hardly has any influence on economic activity.
No stress in the financial markets
2G rules are not a lockdown. Economic output in the euro zone should return to pre-pandemic levels by the end of this year. There are no signs of stress on the financial markets that a central bank would have to counter with massive injections of liquidity. Rather the opposite. Unusual supply bottlenecks are currently affecting the economy. Just as the central bank should not overestimate a temporary outlier in inflation, it must not use an equally temporary setback for the economy as an argument to stick to its crisis policy.
With its crisis program, the ECB is now purchasing bonds worth around 65 billion euros per month. Your current schedule calls for these special purchases to expire at the end of March 2022. Rather would be better. At its meeting on December 16, the ECB should at least announce that it will gradually and noticeably reduce these purchases as early as January.
In addition, the ECB should resist the temptation to partially replace its crisis program with a substantial increase in its normal purchase program of 20 billion euros per month. The financing conditions for households, companies and states are favorable. Even if the yields increase somewhat with fewer bond purchases, perhaps by up to half a percentage point, that would hardly slow the economy down.
The US Federal Reserve intends to end its purchases in June. That doesn’t have to be a benchmark for the ECB. The situation in the euro zone is currently different from that in the USA. There, too, fiscally stimulated excess demand is driving the high inflation rate of over six percent, which, unlike ours, is already reflected in wages.
ECB should end bond purchases earlier
In the US, the Fed is already behind the curve, as it is called in the financial markets. By contrast, the ECB’s policy has so far been appropriate in the euro zone, where there is no excessive demand and only supply bottlenecks and special effects have so far shaped inflation. The subdued growth in loans to the private sector from 3.2 percent recently also proves the ECB to be right.
But in the long run, inflationary pressure will also increase in the euro zone. In our country, too, households made additional savings during the pandemic, some of which they will spend on goods and services in the coming years. Companies want to invest more, and governments are also planning more spending.
Overall economic demand can grow faster than normal over the years. Companies can pass rising costs on to consumers. In the long term, higher wages with increasing labor shortages and the costs of urgently needed climate protection will result in somewhat more inflation.
It is therefore rather unlikely that euro inflation should be only 1.5 percent in 2023 after a decline in 2022, as the ECB predicted in September. Instead, the euro zone will probably have to adjust to inflation rates of around or slightly above two percent in the future. In order to limit this slowly rising inflationary pressure in good time, the ECB should stop all bond purchases earlier and raise its key interest rates sooner than it has so far promised with its buttery soft outlook for its future monetary policy. Otherwise there could still be a real inflation problem in the long run.
The author: Holger Schmieding is the chief economist at Berenberg.
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