VSENTRAL BANKERS in Frankfurt can feel a little baffled. After struggling to revive too low inflation for nearly a decade, they now find themselves hoping that too high inflation will ease. Since the pandemic struck, the European Central Bank (BCE) bought nearly 2,000 billion euros ($ 2.3 billion) of government bonds in order to calm the markets and revive the economy (see graph). He must now ask himself whether such quantitative easing (QE) remains appropriate. This means tackling two questions at its next policy meeting on December 16: whether the eurozone has really escaped its low inflation trap and whether asset purchases have lost their usefulness. The first is easier to answer than the second.
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Inflation in the euro area, as in much of the rest of the world, is skyrocketing. Consumer prices rose 4.9% in November compared to a year ago, the fastest pace in the history of the single currency. A lot of BCERich world counterparts, including the Federal Reserve and the Bank of England, fear inflation is taking hold. In the euro area, however, it may be more likely that, once the disruption from the pandemic subsides, it will remain below the BCEthe 2% target.
To see this, consider the differences between economic conditions in the Eurozone and America. There is less evidence of a booming demand in Europe. Production is still slightly below its pre-covid level, while it is well above in America. The fiscal stimulus in the euro area has been less generous.
Meanwhile, one-off disturbances seem to have played a bigger role in Europe. About half of the inflation rate in November reflected soaring food and energy prices, which are unlikely to last. Other factors related to the pandemic, including a temporary cut in value added tax in Germany last year, also upset the basis used to calculate annual inflation. Remove them by comparing today’s “base” prices to those of 2019, and annualized inflation falls below 1.5%, said Fabio Panetta, member of the BCECouncil of, in November. (The measurement exceeds 3% in America.)
Hawkish types would argue that even temporary disruptions could generate “second round” effects, taking root in wage demands. But a strong pick-up in wage growth has yet to materialize, and measures of inflation expectations are, on average, just below 2%. Following its one-year strategic review concluded this summer, the BCE promised to raise interest rates only if he expected inflation to reach 2% in the next one to two years and stay there. These criteria do not appear to have been convincingly met.
What about the need to QE? The Bank of England is expected to stop making further bond purchases soon; Jerome Powell, the Fed chief, said he would start cutting back on purchases more quickly. But in the euro area, the answer is fuzzy precisely because the inflation picture is different. Some on the BCEThe board of, including Isabel Schnabel, points out that the unwanted side effects of asset purchases are increasing and earnings are decreasing. the BCE will therefore have an interest in giving indications on its interest rates to guide the markets. An unwanted consequence of QE could be that central banks are now major players in government bond markets: BCE owns over 40% of outstanding German and Dutch sovereign bonds, according to Danske Bank estimates.
The expiration in March of one of the BCEThe bond purchase programs, which aimed to counter the effects of the pandemic on financial markets, could provide an opportunity for the BCE stop expanding its presence in the bond markets. But not everyone agrees on the need to reduce asset purchases. Many economists expect BCE instead of supplementing another existing asset purchase program in the coming months, to ensure that bond buying does not run out of steam too quickly. Mr Panetta fears that too much reduction in asset purchases could lead to a “premature increase in long-term interest rates”. In other words, if the BCEthe ultimate problem is that inflation is too low rather than too high, so he might not have the luxury of removing QE. ■
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This article appeared in the Finance & Economics section of the print edition under the title “Emergency Exit”