ECB's inflation hawk Weber has got it totally wrong
By Jeremy Warner Economics Last updated: February 25th, 2010
So that’s it then. The great Axel Weber, guardian of the Bundesbank anti-inflationary tradition and a leading contender to succeed Jean-Claude Trichet as the next president of the European Central Bank, has spoken.
The suggestion by Olivier Blanchard, chief economist at the International Monetary Fund, that raising inflation targets to 4 per cent might help in fighting the economic crisis is not just “playing with fire”, but is “reckless and deeply damaging”. For the German speakers among you, a full version of Mr Weber’s broadside published in this morning’s FT Deutschland can be read by clicking here.
This hardly comes as a surprise. For Mr Weber, being an inflation hawk is not just a matter of economic choice, but a deeply held conviction and almost religiously held belief. In these matters, he is a fundamentalist nutter. You need only a cursory knowledge of German history to see why. Americans draw their cultural understanding of economic calamity from the Great Depression, but Germans take theirs from the hyper-inflations of the Weimar Republic and the immediate post war period. On both occassions, savings were obliterated and in the first case it helped prompt the tragedy of the Third Reich.
So we’ll have no talk of raising the inflation target from Mr Weber, thankyou very much. Give inflation an inch and it will take a mile is his view. Well, maybe he is right, but I would also be careful not so lightly to dismiss Mr Blanchard’s thinking.
For the purposes of the current crisis, inflation targeting has become largely irrelevant. Indeed, failure to recognise this by the ECB is positively harming the eurozone’s recovery. The overwhelming risk is not inflation, but continued economic contraction and deflation. Once a deflationary mentality gets a grip, it is much more difficult to get rid of than inflation, which can easily be quashed through higher interest rates.
This is why the monetary authorities both in the US and the UK are chucking everything they can at the problem, including the kitchen sink. Nobody knows what the inflationary consequences of zero interest rates and quantitative easing might be for Western economies. These are uncharted waters and therefore beyond the parameters of existing economic modelling.
Yet it is plainly better to be attempting to choke off an inflationary boom than to be in a Depression wondering how to get out. In a deflationary debt spiral, monetary policy becomes almost wholly impotent. However low rates go, people will still be keener to pay down debt than invest and consume. The risks of Depression are therefore much worse than those of inflation.
Mr Weber will never be convinced of this argument, but actually, Mr Blanchard’s idea is a good one and in any case only recognises the reality of a situation where the inflation target has ceased to mean very much. In Britain, for instance, the inflation rate is yo-yoing all over the place, yet monetary conditions are being kept as accommodative as is possible to hold back the forces of economic contraction. This is plainly the right approach. It is present enemies, not imagined future ones that need to be fought.
“Should policy makers aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks?”, asks Mr Blanchard and fellow IMF economists in a blue skies report on the future of macroeconomic policy. “Are the net costs of inflation much higher at say 4 per cent than at 2 per cent, the current target range? Is it more difficult to anchor expectations at 4 per cent than 2 per cent?”. These are all worthwhile questions.
As for the Eurozone, for a growing number of countries just the chance of a bit of inflation, any inflation nevermind 4 per cent, would be a fine thing. For countries such as Ireland where prices are falling, even the current ECB rate of just 1 per cent is a very high real rate of interest and therefore completely inappropriate to their circumstances. To them, Mr Weber’s remarks must look like the delusions of Marie Antoinette. Anyone for cake?
Tags: Axel Weber, Bank of England, Bundesbank, European Central Bank, inflation targeting, International Monetary Fund, Jean-Claude Trichet, Olivier Blanchard, US Federal Reserve