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Eurozone Craves More Inflation

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Since 2008, many have complained that the European Central Bank—unlike its very active Japanese and American counterparts—remained idle in its response to the sluggish European recovery. In the fall of last year, the ECB embarked on a program of asset purchases designed to perk up prices in the Eurozone, which have been growing at levels below the 2% target. At the time, ECB chief Mario Draghi had promised to keep the quantitative easing ‘lite’; that is, the ECB would buy only asset-backed securities and covered bonds, and steer clear of government debt. Financial markets responded positively, but prices continued their downward trend. As of this week, when Eurozone price inflation reached negative levels, Draghi decided to throw caution to the wind and brace “for further measures, which could, if needed, be implemented in a timely manner”. Estimates for the European QE program are around €500 billion, but the overall size and timescale will most likely remain open-ended.

The only surprising thing in this turn of events is that Dragi’s less aggressive monetary stance has lasted for so long. I say “less aggressive” because even without an official QE program, the ECB’s balance sheet increased substantially between 2009 and 2012 (see figure). Nevertheless, the many idiosyncrasies among EU member states, markets suffocated by quagmire of laws and regulations, and a wealth of unprofitable investments have made the recovery (read: reflation) bumpier than it has been for the US. Another reason for the ECB’s caution has been Germany’s reluctance to resort to other monetary injections and bail out once more countries that could default on their debt. The fate of the Euro, however—much more than that of the dollar—depends on the fate of such collaboration among central bank governors. Political agreement is crucial to ensure that the EU can expand its redistributive policy and stealthily tax as many people as possible. But this is not an easy task to accomplish. As Mises explained,

… under a system of world inflation or world credit expansion every nation will be eager to belong to the class of gainers and not to that of the losers. It will ask for as much as possible of the additional quantity of paper money or credit for its own country (Mises 2010, 254).

Although Draghi’s resolve to inflate more was to be expected, financial markets remained skeptical this time, and barely budged following this week's announcement. They—and everybody else—anticipated more, and sooner. This ‘easy money frame of mind’, as Mises explained, is part and parcel of the vicious circle of business cycles:

The fact that each crisis, with its unpleasant consequences, is followed once more by a new “boom,” which must eventually expend itself as another crisis, is due only to the circumstances that the ideology which dominates all influential groups—political economists, politicians, statesmen, the press and the business world—not only sanctions, but also demands, the expansion of circulation credit (Mises 2006, p. 128; emphasis added).

The most startling and worrisome aspect of the new round of monetary stimulus is that the ECB’s perceived skittishness has shaken the credibility of the institution (and not in a good way). Which means, in fact, that central banks are being handed a blank check for dangerous policies. They no longer have to tiptoe into huge debt purchases and other ‘unconventional’ measures. Fiat inflation is now seen as a necessary and even sufficient condition for both prosperity and recovery, of which is it is neither. 

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Contact Carmen Elena Dorobăț

Dr. Carmen Elena Dorobăț is a Fellow of the Mises Institute and Senior Lecturer (Associate Professor) at Manchester Metropolitan Business School in the United Kingdom.