The ECB and post-pandemic inflation

Christine Lagarde has issued a warning to governments and “hawks” within the ECB: the eventual rise in inflation, after the end of confinement, cannot serve to justify an anticipation of the withdrawal of monetary stimuli. If this scenario occurs, the ECB should make it clear that it is willing to tolerate a little inflation for some time without disturbing monetary stimuli. For Portugal and other more fragile countries, this clarification will be essential.

The European Central Bank (ECB) is conducting a review of its strategy, for the first time in 18 years. Since then, much has changed in Europe and in the world, due to phenomena such as globalization, China's rise in world trade, demographic changes, digitalization and the various financial crises that have forced central banks to resort to unconventional measures, taking the economy to seas never sailed before, with negative interest rates and countries like Portugal to finance themselves in the markets at historically low rates.

One of the themes addressed in this strategy review is that of the ECB's priorities. European treaties attribute to the central bank, as a "primary objective", the maintenance of price stability, with a positive, low and stable inflation rate. Currently, the ECB aims to keep inflation below - but close to - 2%. Only then do other objectives come, such as contributing to economic growth and sustainability.

Should the ECB pay more attention to some of these concerns, in addition to price stability? And should you review that inflation target?

In recent years, we have become accustomed to virtually nonexistent inflation. If before the pandemic, inflation in the eurozone was low (1,4% in January 2020), it is now in negative territory, with - 0,3% in December. More worrying at the moment is the risk of deflation, so the ECB still has no scope to reduce stimulus and start the long - but inevitable - path back to conventional monetary policy.

That said, while this is unlikely, the extraordinary times we are experiencing may lead to a sudden return of inflation from the second quarter onwards, as Europeans get out of confinement and spend again. This scenario was admitted last Wednesday by ECB President Christine Lagarde at a Reuters event.

Since the start of the pandemic, savings levels have risen across Europe, given that, while maintaining their income, many millions of people are no longer able to buy certain goods and services, such as travel, dining at restaurants or going out at night. So, once the pandemic is under control and the economy reopens, the release of this pent-up demand and the scarcity of some goods and services could lead to higher prices, with companies trying to recover the lost revenue during the crisis. The ECB president therefore launched an alert to central banks, governments and the “hawks” within the ECB itself: the possible rise in inflation, which should be temporary, cannot serve to justify an early withdrawal of stimuli monetary Which would have “very serious risks”, he defended.

For Portugal, and for other eurozone countries, the risk is that an eventual inflationary trend in the post-pandemic may raise doubts in the markets about the continuity of the ECB's measures. Such a scenario would put pressure on the euro's most fragile countries and could, in the end, lead to a sovereign debt crisis, jeopardizing the economies of several countries and the strength of the European project itself.

In this context, Lagarde's statements go in the right direction, as do those of Isabel Schnabel, who sits on the ECB's executive board. In an interview with “Der Standard”, published last Tuesday, this German economist argued that the ECB should make it clear that it is willing to tolerate a temporary increase in inflation, without disturbing monetary stimulus. However, not all members of the Governing Council will think the same way, and resistance is to be expected, partly because negative interest rates favor debtors over savers, a sensitive issue in northern European countries.

In this regard, in that interview, Schnabel responds to the objections of the “hawks”, while recalling, in a timely manner, that the problem of the eurozone is not a matter of monetary policy, but rather a lack of competitiveness. And that it depends on the policies of governments, who are expected to do their part, because negative or low interest rates cannot be maintained forever. “In this situation, a central bank has no choice but to resort to instruments such as debt purchases. Only government policies can ensure sustainable growth and stimulate investment. And then interest rates will also rise, ”he said.

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