If Mario Draghi’s biggest fear has come to pass and yet he does nothing, it follows that he may believe that there is little he can do. Or rather that the costs and risk of what he feels is within the ECB’s ambit aren’t yet worth the potential benefits.
How else to reconcile the ECB’s decision to stand pat on monetary policy with the following statement: “My biggest fear is actually to some extent a reality, and that is protracted stagnation — longer than we have in our baseline scenario,” Draghi told a post-interest rate decision press conference.
That protracted stagnation is easily seen in a euro-wide unemployment rate which is still 11.9 per cent, down only 0.2 percentage point from a record set last year. To be clear, Draghi’s biggest fear instead probably ought to be deflation, which would make any stagnation worse, more damaging and long-lasting. Indeed it could easily turn slow growth into outright recession.
That said, we must meet people where we find them, and Draghi, confronted with an annual inflation rate of just 0.5 per cent at the most recent reading, prefers to attribute this mostly to passing or benign causes. Draghi cited falling energy costs as the cause of lower inflation, and fair enough.
However, we don’t know the path of future energy costs, making monetary policy seem a poor tool to use to diminish negative side-effects that cheaper power might cause. Still, that position is not exactly consistent with its past actions.
“Officials can say what they want about how the fall in the price of energy is aggravating and overstating the decline in prices,” Marc Chandler of Brown Brothers Harriman wrote to clients. “Leave aside the fact that it does not target core inflation. Leave aside the fact that, in 2008, the ECB justified a rate hike because higher energy prices would have broader knock-on effects. The fact of the matter is that the core rate has not been above 1 per cent since last August. Producer prices have fallen 1.7 per cent year-over-year in February, which is the steepest pace since late 2009.”
Draghi also emphasised the role of Easter, which occurs late this year, as having caused a misleading comparison and an artificially low inflation reading. That makes some sense, in that a certain amount of inflationary demand was shifted several weeks back in the calendar. Still, it is hard to blame a surprise fall in inflation on a movement of a feast as well-flagged as that of Easter.
While Draghi did acknowledge that some of the drop in inflation was surprising and negative, it appears that the ECB view is that it is either transitory, benign, or perhaps more significantly, simply a consequence of a needed reform in the Eurozone economy.
That’s surely partly true, but not necessarily an argument against action. Falling wages and living standards in the service of competitiveness may be partly unavoidable, but surely doing that a bit more slowly would be both humane and prudent.
If nominal wages and prices actually turn negative, it opens up a host of potential difficulties, even if you accept that real wages may in some countries have to fall. One area of difficulty is inflation expectations, which Draghi maintains are still well anchored. That’s true if you look at expectations for inflation five years out, but less true over the next couple of years.
Deleveraging too, needed as it is, is harder when inflation is this low, a point Draghi himself seemed to acknowledge. Nothing greases the repayment of crushing debt like a little inflation.
In the end, then, it seems that this may not be about the ills of deflation, but about the ECB’s doubts about its ability to fight it with the tools at hand.
Draghi made the point that QE works better in the US because the US economy is so capital markets-based, making it far more efficient there in raising asset prices. In an economy like that of the Eurozone, which is more dependent on bank lending, creating a corporate bond and stock bubble is perhaps more likely and less useful.
Draghi may find he has new and bigger fears by the end of the year.
