On the expectations – Tim Bartz, Michael Brächer, Kristina Gnirke, Claus Hecking in Der Spiegel:
‘Inflation in the eurozone remained at 5.3 percent in August, which is higher than the ECB had been expecting. Worse yet, the economy is slipping, especially in Germany , the largest member of the currency union.
Experts refer to such a situation as stagflation: The economy has stalled, but prices are still rising quickly, and there is no way out in sight. It's a horror scenario for central bankers.
The dilemma has been developing for months. And the team around ECB President Christine Lagarde, who initially underestimated inflation, have been fighting it for just as long. The ECB has raised its key interest rates nine times in a row since July 2022 (see chart) – more often and more aggressively than at any time since its inception. And inflation has indeed been cut by half since its record high of 10.7 percent in October 2022. But it is still a long way from the 2-percent target the ECB has always stated as its goal. And now the economy is buckling as well.’
(…)
‘Lagarde managed to pacify the ECB's highest decision-making body, and external shocks like the pandemic and the war in Ukraine seemed to bring the brittle guardians of the monetary union more closely together. Even chief economist Philip Lane, who long thought inflation was a myth, was allowed to keep his job.’
(…)
‘But what is true for Germany, the largest country and the most important inflation driver in the eurozone, isn't universally applicable. The currency zone is far too disparate for that. A look at Spain, where inflation rates are comparatively low, shows how complex the interrelationships, and thus the requirements for monetary policy, actually are. In August, prices in Spain rose by just 2.4 percent, half the eurozone average.
The reason is that Spain's center-left government has eliminated the value-added tax on staple foods and halved it for other groceries. Beyond that, Madrid has subsidized public transportation to lower ticket prices and capped rent increases and electricity prices – far bolder moves than those that have been undertaken by Berlin.
Housing costs alone fell by almost 15 percent in Spain in July relative to the same month last year because consumers have to pay less for electricity and gas. The primary reason for this is that Spaniards often sign contracts for rates that are based on current wholesale market prices – unlike Germany, where households usually sign annual contracts with their suppliers at fixed prices.
Whereas electricity is still expensive in Germany because of old contracts, the Spanish, who have short-term contracts, are benefiting from the fact that market prices for natural gas and electricity have now fallen significantly. Inflation in the fourth-largest economy in the eurozone is correspondingly lower.’
(…)
‘Lagarde, whose primary quality is smooth communication, seems almost meek these days. On Monday, the French ECB president said in London that the central bank needs to do a better job of explaining why it sometimes misses the mark with its inflation forecasts. Otherwise, she said, it would be difficult to win back people's trust. "Humility in how we communicate is key to fostering trust." She also said that social media and the nonsense that is sometimes spread there is also making it increasingly challenging for the ECB to "disseminate factual information."’
(…)
‘At the same time, the ECB has jettisoned any long-term forecasts about its interest rate decisions – the outlook is too clouded. On the one hand, this is understandable in light of the confusing economic and inflation indicators and the danger that the line between "doves" and "hawks" will deepen into a trench. Right now, they're united by the fear that people's expectations for inflation will become "untethered." Because as soon as a majority of consumers believe that inflation will no longer shrink to normal levels, the ECB would lose control.’
(…)
‘One possibility would be for the ECB to require commercial banks to increase their minimum reserves at the ECB. Currently, they must park 1 percent of their customer deposits at the ECB in Frankfurt, and no interest is paid on that money. This removes liquidity from the market and, although economists admittedly disagree on this point, weakens inflationary pressure. Suggestions have ranged all the way up to an interest-free minimum reserve of 5 percent.
But Bundesbank head Nagel is giving the idea some consideration. It has the attractive ancillary effect that commercial banks could no longer deposit this money with the ECB at the deposit rate and collect billions completely risk-free – a state of affairs that is causing widespread irritation.
In addition, the ECB could reduce its hugely bloated balance sheet by accelerating the sale of government bonds it holds. The securities accumulated particularly rapidly during the pandemic to make it easier for eurozone member states to incur debt indirectly through the ECB. It is true that the ECB has already started reducing its balance sheet total – an urgent wish of the "hawks" – although it has only done so in small doses.
Still, no major decisions have been made, and central bankers aren't known for hectic changes to their usual ways of doing business, anyway. "Monetary policy is always most difficult at the beginning of a crisis and at its end, when it is time to pull out," says one central banker.
The only catch is knowing whether the end is actually approaching – or if you are only halfway there.’
Read the article here
Predicting the future, even for economists, remains difficult. Especially when the future depends so much on the expectations of consumers.
Basically, a central bank is busy managing those expectations. It’s a thin line where the economist ends, and the clairvoyant begins.
But I do feel for Lagarde.