The European Central Bank has apparently decided to force through the restrictive path it embarked on in the summer – even if it becomes clearer every day that it is wrong. Even large institutions built on rationality like the ECB can run such a childish programme of defiance when their leadership is intellectually overwhelmed and has once surrendered completely to political pressure. Christine Lagarde has rightly become the symbol of this failure because, due to her lack of expertise, she was and is unable to counter the primitive public understanding of inflation and monetary policy that dominates the public debate.
All in all, it can already be stated that politics in the broadest sense is at least as helpless in the second occurrence of price increases stemming from a combination of global supply shocks and speculation as it was the first time around in the 1970s. Of course, politicians are replaced and elected more by chance, but what is frightening is the complete inability of the system to learn from experience.
What do you need to know?
The few logical steps needed to recognise the fatal mistakes that are currently being made should be easy to recite for any third-semester economics student. Supply shocks create a distribution problem and a demand problem in countries that are predominantly consumers of commodities. Overall, there is less income available for the economy to consume or invest. The trade unions cannot solve the distribution problem by force in their favour, because the employers always have the longer (price) lever. However, fiscal policy can do some things to defuse the distribution conflict.
Of course, monetary policy cannot solve the distribution problem either, but it can dramatically exacerbate it if it assumes (as the ECB currently does) that the trade unions will be unreasonable in any case and that they will succeed in turning a temporary price shock into permanent inflation. The ECB raises interest rates without giving the bargaining partners (and fiscal policy!) a chance to find a reasonable solution to the distribution problem. This is a very stupid approach.
It is especially stupid if one ignores the fact that the signs in the EMU are clearly pointing to recession. The way in which a central bank can dampen price increases is always by weakening investment activity through high interest rates, which then has a recessionary effect and slows down wage increases. Consequently, the central bank implicitly believes that a recession has a dampening effect on wage demands and wage agreements, but at the same time it pretends that the recession already underway has no effect on wage negotiations.
The central bank’s position is irresponsible, as there are first and clear signs that reasonable solutions by the bargaining partners are possible under recessionary pressure. In the German chemical industry there is an agreement that without doubt rules out an inflationary development in the sense of a price-wage-price spiral (with regular wage increases of a maximum of 3.25 per cent for each of the next two years) and at the same time provides for a certain income equalisation through clear one-off payments (of two times 1500 euros for all wage groups). If the currently traded inflation forecasts for 2024 turn out to be much too high, the workers have made a really good deal.
In this way, the bargaining partners have solved the distribution problem without being inflationary. If the state intelligently joins in and directly supports the incomes of those who earn little but do not benefit from such collective agreements, then everything that can sensibly be done to ease the distributional conflict has been done.
It should be added that there are also clear signs of easing on the supply side. The prices of almost all commodities that were at the centre of the original supply shocks are now clearly declining. One does not even have to refer to the spectacular turnaround in the price of gas to realize that some speculative bubbles have burst and the supply of many commodities is returning to normal. If there are no new shocks, we can expect inflation rates to fall significantly next year, even without central bank intervention.
The mandate of the central bank
To ignore all this is a failure of the European Central Bank that can hardly be condemned harshly enough. An institution that has been granted such great independence must also have the courage to oppose the political and media mainstream on the basis of a clear and well-communicated diagnosis of the situation.
Christine Lagarde said after the interest rate hike that she does not comment on political debates as a matter of principle. But this is precisely the wrong attitude. Who else but the ECB can objectively counter the all-too-easy prejudices of politicians? Not commenting and simply falling over when the political pressure becomes too great is a first-rate indictment.
Ms Lagarde’s naïve belief that the ECB has a clear mandate, namely to restore price stability, no matter what the causes of the price increases, is also wrong. Maintaining price stability in the medium term does not mean fighting every price increase. It can only mean stopping inflationary processes that have the potential to undermine the population’s confidence in the fundamental stability of the currency.
One has to admit it: The European Central Bank is fighting for credibility and trust on many more fronts than a normal national central bank. But because this is the case, it is also much more important for it than for a national central bank to discuss convincing arguments and well-founded factual analyses with the public and with politicians in the entire currency area. The rulings of the German Federal Constitutional Court and the political ignorance in their wake are the best examples of the need to communicate much more aggressively.
That is precisely what the ECB is doing less and less. It hides behind its mandate and insists on its formal independence. But this is a strategy that is bound to fail, because in the end the only thing that counts is whether it wins the battle for the minds of those who are able to defend monetary policy at the highest level of politics with good factual and analytical arguments.