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Is price stability the right target for the EU?

EU Future | Is price stability the right target for the EU? Anthony Harrington

If ever a man gave a cool and calm presentation at a press conference and got roundly trashed for it later, Jean-Claude Trichet, the president of the European Central Bank is that man. The markets were crashing, European leaders had not yet agreed their $1 trillion support fund for the euro and none of the commentators or assembled press had any idea that a package of this size was on the way. Neither, probably, did Trichet, who was giving his regular press conference following the scheduled meeting of the Governing Council of the ECB on Thursday May 6th. What the markets were looking for from the President of the ECB was a strong indication that the ECB was on the ball and was ready to demonstrate that it knew how seriously contagious the Greek situation could be.

So when a journalist asked Trichet during the press Q&A session if the ECB was ready to put the stability of the eurozone ahead of price stability as its main goal, few seemed prepared for Trichet’s resolute “No!” He said, “We remain firmly attached to the goal of price stability.” Trichet went on to point out to the assembled journalists that the ECB’s record in holding inflation below the EU’s target level of 2% for the entire 12 years since the ECB’s formation, was a truly remarkable achievement, unequalled by any independent government or central bank anywhere in recent times.

This is undoubtedly true, but sadly, most of the assembled journalists seemed to find this to be wildly irrelevant and even misconceived, though no one managed to articulate the problem at the time. That was left to market commentators such as the New York Times columnist, Paul Krugman. In his blog “Shock and Uh?” Krugman expertly dissected the reasons why old-style price stability simply has to be relaxed a touch if the PIIGS [Portugal, Ireland, Italy, Greece, and Spain] and the euro are to survive.

Modest inflation in the centre of Europe, engendered by the ECB going in for “quantitative easing” by printing money to give to EU banks in exchange for dodgy sovereign debt will ease things considerably for the countries on the periphery of Europe (read southern European countries like Greece, Spain, and Portugal).

“A more expansionary monetary policy could make a real difference—especially if the ECB ends up accepting somewhat higher inflation. Suppose that Speece or Grain need to get relative prices down 15 percent over the next five years. If the eurozone has 1 percent inflation, that’s 10 percent deflation in the periphery. If the eurozone has 3 percent inflation, all you need is stable prices. Also, a stronger overall eurozone economy means higher GDP and hence higher revenue, making the fiscal slog less grim.”

In other words, what is needed is for Trichet and his colleagues to “get it.” As that press conference so magnificently demonstrated, by Thursday May 7th, they most certainly had not yet “got it.” The ECB might have 2% inflation and below written into its founding mandate, but that was then and this is now. You can’t throw away the EU rulebook, with its prudent rule about not budgeting for a deficit of more than 3% of GDP, on the grounds that extraordinary times demand extraordinary measures, and then cling religiously to other “rules” that the times have rendered irrelevant. The time for those rules may come again, but the ECB is now in a new game…

Further reading on inflation and price stability



Tags: EU , European Central Bank , European Monetary Union , fiscal stimulus , GDP growth , Greece , inflation , price stability , sovereign debt
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