By: Renzo Forastiero
“The primary objective of the ECB’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.”
The above sentence highlights the main flaw of the mandate given to the European Central Bank (ECB) at the Euro’s inception, inflexibility. It’s what condemned the Eurozone to a double dip recession with extremely high unemployment rates. By contrast, the Bank of England (BofE) (with a flexible mandate focused not just on low inflation but also on growth and employment) engaged in a massive quantitative easing programme that (despite a substantial surge in inflation) managed to restore growth and more importantly, confidence in the economy.
The important factor to be observed when comparing the two policies isn’t the effect they have had on inflation itself, but rather their effect on inflationary expectations. While inflation in the UK has risen well above 4%, expectations have not. In this aspect, trust in the BofE’s ability to meet the 2% target has not been lost, which means prices and more importantly wage negotiations continue to lack upward pressures. This allows the BofE substantial room for manoeuvre to ease the economy’s deleveraging via quantitative easing.
By contrast, the ECB’s insistence on keeping to the 2% inflation target (and failure to do so as inflation stands at 0.7%) has deepened the recession and more importantly exacerbated expectations of a deflation with consumer and business confidence falling substantially. While it is true that southern European economies are chronically uncompetitive and have to undergo a process of internal deflation, the approach taken has worsened the underlying imbalance in the Eurozone by failing to allow wage growth in Germany, in order to make German goods less attractive to Southern European economies.
While the Bank of England has taken a risky gamble in allowing temporarily high rates of inflation, it has paid off in the sense that growth has been restored and unemployment kept at reasonable levels. By contrast, the ECB has not only failed to meet its inflation target, it also has made the Euro an unnecessarily strong currency (it has depreciated far less than the pound) leading to much higher bond yields and a much deeper recession.