“You’re late – but you’re coming,” Field Marshal Illo calls out to Count Isolani in Schiller’s “Wallenstein”. The European Central Bank is also late in fighting inflation, which it has long underestimated. With the cessation of its bond purchase program in the middle of the year, a safe interest rate hike of 0.25 percentage points in July, a very likely second interest rate hike of perhaps even 0.50 percentage points in September and the prospect of possible further interest rate hikes in the further course of the year and thereafter, the Central Bank Council in prepared for a longer phase of combating inflation with a degree of unanimity that is not commonplace. The period of negative interest rates is likely to come to an end in the autumn. Savers will be happy. But if you want to take out a loan to build a house, for example, you should also be prepared for interest rates to continue to rise.
A central bank has no way of directly affecting the prices of goods and services. Fighting inflation aims to make saving more attractive than consumption, make it more expensive to finance spending with credit, and maintain people’s confidence in the stability of the value of money. Monetary policy has an indirect effect on the price level by attempting to curb aggregate demand. Monetary policy works with a delay; According to the Nobel Prize winner Milton Friedman, these delays are “long and variable”.
The ECB can therefore do little about the current inflation rate, which is estimated at 6.8 percent for the current year for the euro area. But it would be able to push the inflation rate close to its 2% target over the medium term.
To achieve this, it is crucial that the ECB does not lose people’s trust. Because if private households do not expect inflation to fall, but rather to remain at a high level or even to rise further, they will not limit their consumption despite higher interest rates, but on the contrary will try to bring purchases forward for fear of sharp inflation. It would be just as devastating if, as a result of a loss of confidence in monetary policy, there were a spiral of ever-rising wages and prices.
With Issing she would have reacted more quickly
The ECB only became aware of the danger of this loss of confidence after a delay. Unfortunately, the inflation rate will probably remain higher than desired for a longer period of time, she announced on Thursday. However, confidence in the willingness of monetary policymakers to act decisively against currency devaluation requires not only unambiguous language, but also unambiguous actions. Looking at the decisions of other central banks in recent weeks, an ECB concerned about its reputation would probably have done better to start raising interest rates by 0.50 percentage points immediately.
The ECB prides itself on its “gradual” policy deployment, which is supposed to exude sovereignty. However, the rise in the inflation rate, which the central bank should act on, is anything but “gradual”. With its first chief economist, Otmar Issing, the ECB would undoubtedly have reacted faster in the current situation than with its current chief economist, Philip Lane, who actually has a reputation as a very competent economist but has dragged the fight against inflation for too long.
The ECB’s handling of bond purchases is also not really consistent. The overdue end of the program goes hand in hand with a waiver of a further increase in the already enormous portfolio of 4.4 trillion euros. But it’s not expected to go back anytime soon. Therefore, the ECB will replace maturing bonds in its portfolio with new bonds. So it remains an important bond buyer in a market where it has no business except in severe crises.
In addition, the ECB reserves the right to react to distortions on the bond markets with new programs if necessary. In plain language, this means that if investors have doubts about the debt sustainability of euro member countries, additional market support from the ECB becomes possible, even if its President Christine Lagarde only spoke vaguely about these intentions at the press conference. It is questionable whether the ECB can free itself from the grip of financial policy in a phase of rising interest rates.
“We don’t come empty-handed either,” replies the Isolani to Illo in “Wallenstein”. In the fight against inflation, the ECB’s hands are not empty either. But they are probably not filled as well as they should be.