Inflation has washed up on Europe’s shores, with prices rising 2% at an annual rate in the eurozone in May. The European Central Bank is likely to join the U.S. Federal Reserve in “looking through” this allegedly transitory inflation, but this won’t be as easy to pull off in Europe as it has been in the U.S.
As in the U.S., there are plausible reasons for believing the inflation surge may be short-lived. Fuel prices accounted for much of the overall inflation, and this is because prices a year ago—the baseline for current data—were so low. Many manufacturers report bottlenecks for components in supply chains, and the end of Covid-19 lockdowns is leading to increased demand and higher prices for services such as travel and hospitality. Some of those inflation pressures will dissipate.
This is the Fed’s justification for sustaining its emergency monetary measures as the pandemic fades, and expect the ECB to do the same. But a complication for ECB President
is that while Washington has shoveled hundreds of billions of dollars into the U.S. economy, most of the European Union’s fiscal stimulus has yet to materialize. That leaves Ms. Lagarde as the only game in town to satisfy demands for someone, somewhere to do something to jump-start Europe’s economy.
Even if it proves transitory, rising inflation highlights the problems Ms. Lagarde will face as she extends the ECB’s crisis policies. Tuesday’s data are the latest evidence that economies such as Germany’s are turning a corner. More than 40% of German construction companies reported delays procuring materials in May, according to a new Ifo Institute survey. Ifo finds that business plans to hire more workers have returned to 2019 levels.
This will raise questions among inflation-hawk German voters and politicians about why crisis measures such as the Pandemic Emergency Purchase Program, the name for the ECB’s latest round of quantitative easing, should persist indefinitely. The ECB’s northern skeptics understand that the real point of these policies is to subsidize borrowing by southern European economic laggards, especially Italy. This could start looking like a bait-and-switch to northern Europeans who may discover that Italian dysfunction causes the ECB to convert a temporary measure into a permanent one.
The best, and perhaps only, argument for extending the ECB’s current policies beyond the pandemic is that, by reducing Rome’s borrowing costs, Ms. Lagarde gives new Italian Prime Minister
fiscal running room to pass economic reforms. And he’s trying, having recently unveiled a package that includes overhauls of public administration and the judiciary, among other things.
Ms. Lagarde has to hope he succeeds. She can hold off the inflation hawks for now, but if inflation is persistent the day will come when she can’t, and shouldn’t. Europe’s monetary state of emergency can last a bit longer, but don’t assume it can last indefinitely.
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