Dhe monetary policy meeting in Jackson Hole was a welcome sign of the willingness of the major central banks to take decisive action against inflation – even if this fight will unfortunately have temporary negative consequences for the economy and employment. It doesn’t help: past experience teaches us that a belated reaction of monetary policy to high currency devaluation does not reduce the overall economic costs of combating it, but on the contrary drives it up even further.
This also applies today. All attempts to interpret the inflation of our time as a special phenomenon that will soon disappear by itself and therefore does not require a strong monetary policy response have failed.
Hopes were already spreading on the financial markets that inflation had peaked in the United States and that the Federal Reserve would therefore refrain from further significant interest rate hikes. Those hopes were ruthlessly dashed by Fed Chair Jerome Powell in a short but succinct speech on Friday. Powell’s announcement of further tight monetary policy met a surprised stock market, which reacted with significant price losses.
Danger of a price-wage spiral
Even more notable is a contribution from ECB Executive Board member Isabel Schnabel on Saturday. For a long time, the European Central Bank underestimated inflation even more consistently than the Fed. Schnabel’s unequivocal remarks at the conference can be interpreted as an expression of a growing conviction in the ECB that the fight against inflation in the euro area should finally take place quickly and consistently. Schnabel mentioned a scenario in which a central bank that simply lets inflation run wild could lose popular confidence. In this case, combating inflation would become even more difficult for monetary policy.
Schnabel’s contribution clarifies the absurdity of some economists’ trivialization of the risk of a price-wage spiral with reference to the most recent, still moderate wage agreements. For monetary policy, however, it is not the past that counts, but people’s expectations about the future. With inflation in excess of 8 percent and the prospect of further exorbitant increases in energy prices, which could result in double-digit inflation in the autumn, it does not take much imagination to see significant wage pressures arising in a situation characterized by labor shortages. This wage pressure would become all the worse the more confidence in the restoration of price level stability would be called into question by monetary policy. An increase in the key ECB interest rates by at least 0.50 percentage points in September is therefore urgently needed.
With good reason, the responsibility for the stability of the overall price level lies with monetary policy, which must be aware of its immense responsibility, especially in difficult times. The possibility of a sustained loss of confidence in central banks requires consistent action.
Governments cannot replace central banks in combating high inflation rates, but they can support them. In Europe, especially in Germany, a coherent energy policy is part of this, even in difficult times. The extremely strong increase in the wholesale prices paid for gas and electricity for the coming year is currently attracting attention and uncertainty. These prices are snapshots and need not be permanent, but should be taken as a call to action.
Above all, however, governments must pay attention to the sustainability of their public debt, not only because of monetary stability. There is no strict general connection between government debt and monetary stability. However, should national debt become so high that the central bank has to secure its financing in the long term, well-founded doubts will arise about the ability of monetary policy to ensure a stable price level.
Like the Fed, the ECB must be able to scale back its huge balance sheet sooner rather than later by reducing its bond holdings. Even if some governments may not accept this: debt rules are not an annoying ballast.
