New Narrative About Monetary Policy: The Specter of Inflation

Dhe sentiment in the euro area is brightening. Consumers and businesses are more optimistic about the future. At the same time, consumer prices are rising faster. In August, inflation in the euro area was 3 percent. In Germany, measured by the Harmonized Consumer Price Index, it reached 3.4 percent, the highest value in 13 years. It should initially continue to rise until the end of the year. Understandably, these developments are worrying people. Higher inflation lowers purchasing power and reduces inflation-adjusted wages and interest income. The very low nominal interest rates add to these concerns. Because the private banks are increasingly passing negative interest rates on to their customers.

An objective classification of the most recent price increases and future risks is important because fears are being fueled in Germany in particular. There is talk of “Weimar conditions” and parallels are drawn with the 1970s. I will explain that these comparisons are misleading. There is not the slightest indication that current monetary policy will lead to permanently higher inflation or even to hyperinflation.

The economy was in a vicious circle

The benchmark and compass for assessing inflation risks is our new monetary policy strategy, which the Council of the European Central Bank (ECB) unanimously adopted in July. The centerpiece is a symmetrical inflation target of 2 percent annually in the medium term, which replaces our previous target of below, but close to, 2 percent. The new target makes it clear that we view persistent upward and downward deviations as equally harmful. This clarification is important because we have had to contend with inflation that is too low rather than too high in the past few years. Since the global financial crisis, inflation has averaged only 1.2 percent in the euro area and 1.3 percent in Germany, i.e. well below 2 percent.

Too low inflation also poses a threat to price stability. The decline in inflation and inflation expectations was primarily an expression of the lower long-term growth prospects in the euro area. The economy found itself in a vicious circle of weak demand, poor corporate profitability, meager wage increases and low price increases.

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