The important policy strategy adopted by the European Central Bank this month wasn’t decided without a fight. Especially last week’s decision on its so-called “forward guidance on interest rates” to keep interest rates low for an extended period – until inflation projections are in line with the target “well ahead” of the end of the forecast horizon, which can stretch as much as three years into the future –caused a “rebellion” and the “biggest disagreement among policymakers” since September 2019”.
In particular an attempt by the French ECB President, Christine Lagarde, to push through a reference to get inflation to “at least” 2 percent was blocked. This by Isabel Schnabel, one of two Germans in the ECB’s decision making bodies. It was scrapped in favour of a pledge to target inflation “below, but close to, 2%.”
Out of 25 governing council members, two Central Bank governors still did vote against: the other German representative, Bundesbank chief Jens Weidmann, who has warned that a five percent inflation rate for Germany by the end of this year is possible, and Belgium’s Central Bank governor Pierre Wunsch, which marks the most hawkish move by a Belgium Central Bank governor since the launch of the euro.
In a way, this should not surprise, given how Belgians have been suffering the worst real negative rates among all inhabitants of the Eurozone, amounting to 2.03 percent between 2004 and 2017 according to one study, both due to the comparatively low interest rates offered by Belgian banks to customers as well as the comparatively high inflation in Belgium.
Wunsch himself explained his move by arguing that being too accommodative now may reduce the room for the ECB to react in case inflation remains elevated, stating that “if we wait too long now to increase interest rates, there may be a risk that we may need to do so more forcefully in the future”.
He added: “I am pretty sure inflation will increase during the next two to three years”, pointing at increased energy prices in Europe as a result of the reduction in CO2 emission permits but also at the inclusion of owner-occupied house prices in inflation measuring.
One can only wonder why house prices weren’t included so far, but there’s still a lot more wrong with inflation measuring. Jürgen Stark, who resigned as ECB chief economist back in 2011, has questioned the idea of “core inflation” , which excludes food & energy, as these would supposedly be too volatile, declaring that core inflation is “only useful to people who do not eat or move”.
Afterwards, also Austria’s Central Bank governor Robert Holzmann came out against Lagarde’s line:
#ECB dissenter! Austrian Central Bank Governor tells us that he had 'reservations' on the ECB revised fwd guidance like Weidmann and Wunsch. Why?
He lists 3 reasons 1/ too prescriptive (2025 earliest hike) 2/ define underlying inflation 3/ needed an escape clause @ECB pic.twitter.com/2GKc8drDa6
— Joumanna Bercetche 🇱🇧 (@CNBCJou) July 27, 2021
Ever looser
In any case, Lagarde managed to push through yet another loosening of the ECB’s monetary policy, which comes on top of the loosening of the inflation target and the “greening” of the ECB’s policies decided earlier this month, which even involves an actual ECB “action plan to include climate change considerations in its monetary policy strategy.”
When presenting the decision in early July, Lagarde maintained that the ECB had stopped short from adopting the “average inflation targeting” pursued by the U.S. Federal Reserve. This would mean making an explicit commitment to overshooting the inflation target after missing it for a longer period. The ECB only allows for the possibility for a temporary overshoot to happen.
In that respect, it’s telling to see Lagarde pushing for a reference to get inflation to “at least” 2 percent only two weeks after it was decided not to copy the Fed. She’s likely to continue to push for this, as this is also the desire of those politicians in the Eurozone that are having to deal with monstrous debt burdens that would easily spire out of control in case of higher interest rates. A former politician herself – who has even been convicted of “negligence” in allowing the misuse of public funds as Finance Minister – Lagarde truly embodies the politicization of the ECB.
No free lunch
Fundamentally, to see two percent inflation as a “target” to be reached is already questionable. Surely, few people are aiming for an annual loss of two percent on their investments or savings. Nevertheless, this policy is already in place since 2003. Before, the ECB considered the two percent as a maximum that should not be crossed, which is basically more in line with common sense.
Common sense is not exactly a typical trait for Central Banks. Still, things can always be worse. In Japan, the Central Bank has even become the largest investor in Japanese stocks, with shareholdings valued at $470 billion, something which is now heightening concerns about market distortions and conflicts of interest within the central bank. Then, at the moment, monetary growth in the Eurozone is much higher than in Japan. Monetary policy isn’t just about interest rates or the specifics of asset buying programmes. It relates to the whole regulatory framework controlling bank lending. The new state guarantees, decided in the context of the Covid crisis, promising private banks to suck up investment losses, are yet another factor able to fuel the cheap money cannon.
At the end of the day however, there is no such thing as a free lunch. Any newly created euro – whether printed or in digital form – debases the value of an existing euro with an equivalent amount.
Any favorable treatment – whether in the form of the ECB buying a bond from a certain company because it is deemed “climate” friendly or in the form of a refusal by the ECB to fund a private bank at certain terms because the collateral presented would not be “climate friendly” – is a bureaucratic distortion and will ultimately come with a cost in terms of lost competitiveness.
Also the idea that the ECB’s cheap money policies would provide some breathing room for Eurozone governments to enact competitiveness reforms, once touted by former ECB chief Mario Draghi, has proven to be farcical in Draghi’s Italy and beyond. On the contrary, governments tend to enact reforms when the lack of economic growth and accompanying lack of tax income are beginning to deprive them of cash. That was the case for Ireland in the 1980s, for example. When the Treasury is plentiful, policy makers do not really feel the consequences of high youth unemployment or the lack of economic growth and dynamism. It is only when they experience an empty wallet themselves that they will finally realise there is a problem.
