The ECB’s dilemma is very similar to that of the US Federal Reserve, the Bank of England and many other central banks: monetary policy cannot do everything, the damage caused by the pandemic has not abated and there There is no painless way to respond effectively to Russian aggression. Yet, as best they can, central banks must strike a balance between supporting demand and controlling inflation. The ECB is wrong. It has become an outlier in its approach and needs to be rethought.
Both the Fed and the Bank of England have raised interest rates and signaled to financial markets that there is more to come. They dropped talk of “transitional” inflation months ago – and acknowledged they should have changed course sooner. The ECB is still far behind. It has not yet raised its key rate, which is at minus 0.5%. Its latest signal suggests the first increase will be just a quarter point – not when its policymakers meet next week, but at the meeting afterward in late July.
With inflation above 8%, a policy rate below zero in nominal terms maintains an extraordinary and increasingly reckless level of additional demand. Too much stimulus applied for too long adds to the danger of a violent correction later. The cost of avoiding a moderate downturn now could be a deep recession in due course.
Admittedly, the ECB faces bigger problems than the Fed or the Bank of England. The EU is more heavily dependent on Russian energy, so the supply component of its peak inflation is larger. Its benchmarks for growth and employment are lower, leaving less room for error on downsides. Economic conditions also vary widely across the Eurozone, as do levels of inflation tolerance. (Prices are rising about 5.8% per year in France, 8.7% in Germany and 20.1% in Estonia.) Good monetary policy in one country will not work in another.
Similarly, the ECB must take into account the fact that the coordination of fiscal policy between the 19 members of the euro zone is difficult. Some have chronic public debt problems, now compounded by pandemic-related spending. This makes higher interest rates more dangerous and their effects harder to assess.
The ECB’s reluctance to remove stimulus is understandable. But the balance of risk has changed. The surprising new inflation figure warrants – and the broader situation demands – a direct reset. Without further ado, the ECB should launch a deliberate effort to normalize policy, starting with a 50 basis point hike next week, not next month.
More from Bloomberg Opinion:
• Fed’s subdued inflation forecast needs explaining: Bill Dudley
• Don’t want the Fed to suspend rate hikes in September: Mohamed A. El-Erian
• Rishi Sunak’s helicopter drop makes life easier for the Bank of England: Marcus Ashworth
The editors are members of the Bloomberg Opinion Editorial Board.
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