Is the ECB really an outlier?
The last time German inflation was as high as it is today, in June 1992, the Bundesbank’s key rate, the Lombard rate, was 9.75%. Today, the European Central Bank, the successor to the Bundesbank, charges banks in Germany, as well as the Eurosystem at large, zero.
Much has changed since the summer of 1992. Twenty-nine years ago, the unified German state was in its infancy and monetary union had yet to be born. It is, according to a note released Tuesday by research firm Laburnum Consulting, the latter of these two changes that explains the most why the gap between yesterday’s and today’s rates is so wide.
At the dawn of 2022, the ECB is breaking with another tradition. For the first time in more than a decade, policymakers in Frankfurt are charting a different course from that followed by the Federal Reserve and the Bank of England, each raising interest rates or preparing to consider them in future. next months. in response to the surge in inflation observed over the past year. The ECB, for its part, is expected to leave its rates unchanged for the duration of this year. Laburnum’s memo – written by founder and former Bank of England chief John Nugée and economist Gabriel Stein – believes part of this is because the eurozone’s monetary guardian sets policy with sovereigns in mind. the most heavily indebted in the region:
Why is the ECB so reluctant to act? We believe the answer might be the fear that the political consequences of an aggressive attempt to reduce inflation will outweigh the economic consequences of continued inaction. And behind that, we feel a fundamental change within the ECB itself …
One of the main features of the pandemic has been an increase in EA public debt, especially (but not exclusively) in southern Europe. According to The Telegraph, France’s debt-to-GDP ratio is currently 118%; that of Spain is 120%; and that of Portugal is 135%. Much more worrying, that of Italy is 155% and Greece’s debt / GDP ratio, after repeated restructuring and amortization, is 206%!
These are alarming numbers, and even more worrying for the ECB will be the contrast with Northern Europe, where Germany’s debt-to-GDP ratio only increased by 4 percentage points over the same period, from 65% to 69%.
As a result, the ECB is essentially trying to provide monetary policy for two very different economies, one very heavily in debt and the other a little less.
This, according to Nugée and Stein, should lead the ECB to be criticized, once again, in the German popular press for having favored the most debauched members of the monetary zone, to the detriment of the most parsimonious.
We agree that this narrative is likely to unfold. And it may seem, over the months, that the ECB is reluctant to withdraw its support for reasons that economic factors alone cannot explain.
While workers here have yet to experience the kind of wage growth their American counterparts have, there are increasing signs of strain in the labor market. Here’s a graph from an email from economists at Nomura, which sparked our interest when it landed in our inbox in mid-December:
However, while the ECB is an outlier in terms of its plans for the coming year, central banks may still have much more in common with each other than they do with previous generations of policymakers.
Despite the Fed’s shift in rhetoric, the yawning gap between current rates and then rates is of a similar magnitude in the United States and Germany. The last time US inflation exceeded 6%, in the fall of 1990, the effective federal funds rate was around 8%. Today it is hovering above zero.
There is a gulf between where rates are now and where they were when we last saw inflation as high as it is now.
There are good reasons why they don’t need to be as high today as they were in the early 1990s. For example, governments, businesses and households are now more in debt – relatively small rate hikes will have a bigger impact on behavior than in the past. Price pressures can be a different beast this time around, too. Some of the inflation we’ve seen in recent times is in the markets for goods such as used cars. Such inflation is linked to supply shortages linked to the pandemic and may well subside as businesses adjust to a world with Covid-19.
Still, a question hangs over the extent to which aggressive fiscal spending and monetary easing has led to something more lasting for inflation than flaws in global supply chains alone can justify. The rates do not need to increase by up to 10 percent. But if (and – in our opinion – it remains a big if), higher inflation becomes rampant, so they’re going to have to rise much more than any policymaker will admit.