Beans: Europe Have Too Much -Not Too Little- Inflation

Once again we see the strange spectacle of the ECB being nearly universally attacked for pursuing a "too tight" monetary policy by EU-politicians and other pundits including the OECD when it objectively pursues a highly inflationary policy.

Contrary to the widespread misconception of the ECB as inflation hawks, the ECB have pursued a extremely loose monetary policy. Real short-term interest rates is negative and according to the latest numbers, money supply growth was 8% in October, far above the ECB's own "reference value" of 4.5%. And while the ECB is supposed to keep consumer price inflation below 2%, the harmonized index of consumer prices was 2.4% in November according to preliminar figures. But since this excludes housing costs, real consumer price inflation is higher.

But the fact that consumer price inflation is a percentage point or so above ECB targets greatly underestimate the damage caused by the ECB's lax monetary policy. The ECB's lax monetary policies have far from the intended effect of raising inflation and growth in Germany had the effect of creating a housing bubble in the rest of the euro-zone.

That in turn has caused great imbalances, including much higher debt levels and declining savings. In Ireland, household debt has risen from 50% of disposable income in 1995 to 120% today. Household debt in Spain has doubled from 50% in 1996 to 100% today and similar trends can be seen in most other countries. The spending spree created by the ECB have also had the effect of lowering savings in most countries, which is reflected in the deteriorating current account balances with the surplus for the euro-zone now turning into a deficit, despite a rising surplus in Germany. Italy, France and Spain have all seen their current account balances deteriorate dramatically with Spain now running a deficit as large as America's relative to GDP.

All of this points to a far too loose monetary policy, which have created economic imbalances which could get serious if the policy is continued.

The only argument used for the myth of ECB as a inflation hawk is that European growth is weak and fragile and unemployment still high. But this is based on the Keynesian/Philips Curve mythology of weak growth being the result of a insufficently inflationary monetary policy and curable by pursuing more inflationary policies. One would have thought such episodes like the German hyper-inflation in 1923 or the stagflationary 1970s or today's Zimbabwe -which this year is expected to have 400% inflation, 60% unemployment and a GDP falling 7%- would have taught pundits that inflation can at best only provide a short-term boost and will not raise long-term growth. In the end the price increases caused by past monetary inflation will reduce purchasing power. And once the property bubbles throughout Europe bursts like they did a few years ago in Holland, the economy will suffer just like it recently have in Holland.

Further illustrating the fact that loose monetary policies can't solve structural problems is the case of Italy where people have responded to low interest rates far more than in Germany and borrowed heavily to consume and bid up house prices, yet growth have been as weak as in Germany.

If EU politicians truly wanted to raise growth they would downsize the bloated welfare state and relieve companies of the high regulatory burden. But as the welfare state and the rigid labor market is part of the sacrosant "social model", they won't touch that.

The ECB made a big mistake when it caved in to the demands to lower short-term interest rates to 2% in 2003. And it also made a mistake by only raising a quarter point now. This means that the asset price bubbles will be further aggravated and create even more future problems. Problems which of course will be blamed on "tight monetary policies".

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