The ECB is now facing a textbook supply shock, says the author.
(Photo: dpa)
The announcement of Jens Weidmann’s resignation and an inflation rate of 4.5 percent, the highest value in 28 years, have blossomed a powerful and dangerous narrative about the European Central Bank (ECB): It is now on its downward path towards a too loose monetary policy unstoppable.
The legend begins with the fact that the history of the ECB can be divided into two epochs, a good phase from 1999 to 2011 under the aegis of German chief economists and a bad phase that began at the end of 2011 with the presidency of Mario Draghi.
This is a misunderstanding of history. Because the ECB made serious mistakes in the years 2008 to 2011. It still raised the key interest rate in July 2008, while the US Federal Reserve had already lowered them drastically since July 2007 under the impact of the financial crisis. After the Lehman bankruptcy on September 15, 2008, it took almost a month for the ECB to react in terms of liquidity policy.
In the middle of the euro crisis, in April 2011, she came up with the idea of raising interest rates. With these wrong decisions, it destabilized the euro area in the supposedly “good phase”.
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It was Mario Draghi who stopped this quackery. The fact that he bought bonds for this is held against him in the narrative as a break with the Bundesbank tradition, even though the Bundesbank itself bought bonds on a large scale in 1967 and 1975.
ECB faces supply shock
Weidmann is portrayed in this story as a lonely admonisher who warned early, but unsuccessfully, of dangerous undesirable developments. But what actually went wrong before the outbreak of the pandemic? The economy in the euro area has picked up speed again without the inflationary tendencies feared by German economists having occurred.
Peter Bofinger is Professor of Economics at the University of Würzburg and was a member of the Expert Council.
(Photo: SVR)
And even today, the inflation rate in the euro area, excluding energy prices, is 2.0 percent. Independent forecasters expect a rate of 1.9 percent for 2022 and 1.7 percent for 2023. The fact that oil prices have returned to the level of autumn 2018 after a temporary slump can hardly be attributed to the policy of the ECB.
The ECB is now facing a textbook supply shock. Inflation rises and economic output falls. If it were to raise interest rates in this situation, the economy would be further weakened. It is better to wait and see whether this will lead to a wage-price spiral. So far there has been no evidence of this in the euro area.
In such a situation, the narrative of an ECB on the wrong track in terms of stability policy is extremely dangerous. The more people are persuaded that the temporarily increased inflation will become permanent, the more difficult it will be for the unions to conclude collective agreements that will lead to a decrease in inflation. Honest men can thus become arsonists.
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