The End of Free Money by Hans-Werner Sinn
Soaring inflation in the European Union should be a clear signal to policymakers and central bankers that the time to stop funding public debt crises was yesterday. Most likely, the continent is heading into a period of stubborn inflation that will be familiar to anyone who lived through the 1970s.
MUNICH – Although the US Federal Reserve is now considering reducing its monthly asset purchases in light of rising inflation figures, European Central Bank President Christine Lagarde continues to insist that there is no risk of sustained inflation. Currently measured inflation, she says, is a temporary problem that will go away once the bottlenecks are overcome, so the ECB will not change its policies. It is like a coachman who refuses to take the reins when his horses embark, because they will eventually tire.
Never mind that, according to the Maastricht Treaty, the ECB is obliged to ensure price stability in all circumstances. There is no provision for the possibility of allowing prices to soar for a period of time. And, unlike the Fed, the ECB cannot legally seek to balance the objective of price stability with other monetary policy objectives.
Current supply bottlenecks owe a lot to quarantine measures at ports – especially, but not exclusively, in China. Ships on arrival cannot unload their cargo and therefore cannot be loaded with intermediate products that the European economy must be able to supply to its customers. Freight tariffs for international maritime transport have increased eightfold since 2019. But bottlenecks also reflect nationally imposed lockdowns across European economies last winter and spring, which resulted in even shortages of electricity. local timber and other building materials produced in Europe.
Thus, in a survey by the Ifo Institute in the fall of 2021, 70% of German manufacturers reported difficulties in sourcing upstream products. By comparison, the highest figure ever reached in the last 30 years of investigations was 20%. Ifo estimates that bottlenecks will cost Germany around 40 billion euros ($ 45 billion) in added value, or the equivalent of 1.15% of its GDP, in 2021.
Supply bottlenecks have obviously been unbearable to the huge stimulus and bailouts that European governments implemented during the COVID-19 crisis. The German Federal Government, for example, has promulgated programs amounting to around 10% of German GDP over two years, and the European Union has promulgated additional programs amounting to 4.5% of German GDP. the EU over two years. These programs were largely funded by new government debt, which in turn was immediately monetized by the ECB and therefore issued at ultra-low interest rates.
Europe has never experienced stimulus programs of such magnitude. But given supply bottlenecks, policymakers were effectively pressing gas with the handbrake still on. The result has been a particular form of economic overheating that economists call stagflation.
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Inflation rates are now very high not only in the United States, where they stand at 6.2%, but also in Europe. In October 2021, prices in the euro area as a whole had increased by 4.1% year on year; in Germany, the continent’s largest economy, prices rose 4.5%. And as if that were not enough, the German Federal Statistical Office has just announced that annual industrial production prices were up 18.4% in October. This is the largest increase since 1951, shortly after the creation of the Federal Republic of Germany, even exceeding the monthly peak of price increases during the oil crises of the 1970s (14.6% in June 1974).
Unlike the consumer goods index, which measures only the prices of finished products, industrial producer prices capture all intermediate stages of production. They therefore have some prognostic significance for consumer prices, although the end products will not show such extreme peaks. (Unlike the latter, they are unaffected by value-added tax changes such as those occurring in Germany.)
These new inflation figures are so extreme that the ECB’s stance looks like a willful denial. Germany is currently experiencing the highest inflation of its life. And the situation is not much better in other European countries. In September, France reported an annual increase of 11.6% in industrial producer prices, and this figure stood at 15.6% in Italy, 18.1% in Finland, 21.4% in the Netherlands. Low and 23.6% in Spain.
Worse, these increases do not look like a temporary phenomenon. Even though supply bottlenecks will likely be overcome by next summer, unions will then have increased their wage demands to reflect this year’s inflation numbers. This will trigger a spiral of rising prices and wages that could continue for several years. Durable consumer goods purchases will be pulled forward, further accelerating inflation.
Moreover, even when the first wave of inflation begins to ebb, perhaps as early as next fall, new dangers will emerge. If the ECB is reluctant to follow the predictable US Federal Reserve interest rate hikes, the euro will depreciate, pushing import prices further up. The transition to retirement of the baby boom generation involves many additional consumers who no longer support production and therefore create excess inflationary demand. On the cost side, the phasing out of all fossil fuels – and nuclear power plants in Germany – will be a major driver of price growth. It takes little imagination to see how Europe could find itself in an environment of stubborn inflation similar to the 1970s, which could last the rest of the decade and beyond.
Under these circumstances, European economies and the ECB must receive a clear signal to stop any further frenzy of monetized debt. If policymakers want to divert money from the economy for their purposes, they should be forced to cut other spending by a comparable amount. If rollback via interest rates no longer works because the ECB is not playing ball, it will be replaced by a direct foreclosure mechanism via property prices.
Either way, today’s inflationary surge marks the end of the pipe dream of resources created from nothing. The good life financed by the printing of the euro is definitely over.