Inflation at a record level: “The ECB is doing everything right”

Inflation at record levels
“The ECB is doing everything right”

01/17/2022, 8:13 p.m

Inflation has been high for months. But the European Central Bank is still keeping interest rates low. Economist Sebastian Dullien doesn’t think that’s an Ferror. “At the moment it doesn’t look as if inflation expectations are going to get out of hand,” he says in an interview with ntv.de.

ntv.de: The inflation rate in the euro area rose to 5 percent in December and thus to the highest level since the introduction of the euro. Is the ECB underestimating inflation?

Sebastian Dullien: No. In my view, the ECB has done everything right so far. Because what we are seeing is not inflation in the sense that rising prices lead to rising wages, which in turn push prices up. At the moment, special effects in particular are causing the measured inflation rate to rise temporarily.

Disrupted supply chains and high energy prices are repeatedly mentioned in this context. Which does not change the fact that interest rate hikes are considered a classic means of combating inflation.

That’s what they are. But you have to realize that interest rate hikes only take effect after a certain delay, i.e. after about four to six quarters. They achieve their effect by slowing down domestic economic activity, which tends to ease the pressure on prices. However, most economists are currently assuming that energy prices will at least not rise as much and that inflation will therefore fall on its own this year. The same applies to the supply chains. Here, too, it is generally expected that the disturbances will gradually disappear. In other words, an interest rate hike would take effect the moment these problems probably no longer exist. It would lead to reduced economic activity and thus to higher unemployment. That wouldn’t help anyone.

But there are economists, such as Volker Wieland, who warn that inflation will take hold.

When there are such large price increases, there is always a risk that something will change in the broader perception. If higher prices are expected in the long term and this leads to higher wages as a result, then inflation can set in. But you can’t see any of that. In both Germany and the euro zone, current wage developments could even be slightly higher than they are at present and would still be compatible with stable inflation of two percent.

Other central banks have initiated interest rate reversals and are preparing the markets for further rate hikes, above all the US Fed. Is the situation there so different from that in the euro zone?

In the USA – in contrast to Europe – there are already significant wage increases in some areas. This also has to do with the fact that the economic recovery in the USA is more advanced than in the euro zone. There you can see bottlenecks in the labor market. A central bank must react to this. In Germany, on the other hand, there is only anecdotal evidence that individual companies report problems finding employees. But that is not reflected in the macroeconomic numbers.

The inflation rate is not just an abstract number. Many people feel it – purchases become more expensive, savings lose value. How long can the ECB afford to ignore this?

The ECB expects inflation to be back in the green in about 18 months. However, if new forecasts indicate that inflation will still be well above the target of two percent by the middle of next year, or if price increases will lead to higher wages in the long term, then the ECB will have to act.

Against this background, isn’t it a mistake that ECB President Christine Lagarde has categorically ruled out interest rate hikes for this year? Because in this way it can encourage the fear that inflation will take hold.

For medium-term inflation, it is not so important whether the ECB hikes interest rates this year or not. Even with interest rate increases not until 2023, inflation could be caught again. Nevertheless, one can of course criticize the fact that the ECB has ruled out interest rate hikes until the end of the year. Because the world can change so much that this step is inevitable. However, it currently does not look as if inflation expectations will get out of hand.

Fear of inflation can lead to higher inflation. How high do you rate the risk of a wage-price spiral?

I would rather speak of a price-wage spiral. You have to figure out what came first. It’s not as if wages are rising and prices are going up as a result. The most that could happen is that the parties to the collective bargaining agreement say that higher prices must be compensated for by higher wages. For such a price-wage spiral, however, it is not the demands of the unions that are decisive, but the respective agreements. And they have a lot to do with the situation on the labor market and the economic situation. Against this background, it is currently very unlikely that there will be wage agreements that would pose a threat to price stability.

Does another motive also play a role in the monetary policy of the ECB? The accusation: You take into consideration the heavily indebted countries of the euro zone, which will bring higher interest rates into considerable difficulties.

In terms of debt sustainability, it makes more sense for a central bank to raise interest rates in good time. If it raises interest rates too late, this means that inflation is getting out of control. Then interest rates have to be raised even more. That would cause significant problems and cause a deep recession. The ECB can therefore have no interest in keeping interest rates permanently lower than would be compatible with its inflation target. In addition, a rapid interest rate hike of half a percentage point, for example, would not pose any real problems for countries like Italy – in the 1990s the budgetary burden of interest payments there was much higher than it would be today even with such an interest rate hike.

Jan ganger spoke with Sebastian Dullien.