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Get loose

8 May 2012 By Pierre Briançon

The Bundesbank keeps raising concerns about a possible surge of inflation in the euro zone. But the fears are premature at best. The European Central Bank hasn’t failed on that front. While the current 2.7 percent inflation rate is above the ECB’s official goal of “below but close to 2 percent”, it expects to be back on target in early 2013. The question is whether sticking to that stubborn 2 percent goal makes sense as recession threatens.

The ECB is keeping its key interest rate at 1 percent, much higher than the near-zero levels in the United States and UK. The economies’ near-term prospects don’t justify the euro premium. The euro zone’s gross domestic product will shrink by 0.3 percent this year, according to the latest International Monetary Fund forecast, compared to 2.1 percent growth in the United States and 0.8 percent in the UK.

The monetary purists at the Bundesbank fear that lower euro rates – or even too many months at the current level – will fuel inflation in Germany. It’s possible, even though in the year ended in March, prices rose by 0.4 percentage points less in Germany than in the euro zone as a whole. Faster growth in Europe’s largest economy could reverse the gap this year, especially if German workers succeed in their demands for higher pay after a decade of strict wage discipline.

Yet higher German inflation shouldn’t be feared, but hoped for. It would make looser monetary policy more effective where help is most needed. Prices are rising slower than the average in troubled euro countries like Greece, Spain or Ireland. Higher inflation in Germany would help them regain some competitiveness. And it would help rebalance the euro zone economy, after a decade when German exporters gained market share throughout the region.

Mario Draghi, the ECB’s president, is unlikely to say so, but in an ideal world he would: inflation in the euro zone is not a threat. And more of it in Germany could be good for Europe.

 

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