What they say and think at the top of the ECB
Thesis and scenarios of the chief economist of the ECB, the Irishman Philip Lane. Giuseppe Liturri's analysis
In a 2023 dominated by uncertainty about the future of the economy, one thing appears relatively certain: central banks will determine, both for what they do and for what they do, the direction and speed of progress.
All eyes are on the decisions of the Fed and the ECB, which already in 2022 caused interest rates to rise – albeit to varying degrees – with a speed that has few historical precedents.
On the subject, the President of the ECB has certainly not shone for clarity so far Christine Lagarde who, let us remember, is not an economist, and so we must rely on the words of the chief economist of the ECB, the Irishman Philip Lane who knows what he is talking about and he is the main inspirer of the moves of the Eurotower Board of Directors.
WHAT LANE (ECB) SAID TO THE FINANCIAL TIMES
On Tuesday 17 January, Lane gave the Financial Times a long and interesting interview – very well argued but ignored by the Italian newspapers, all intent on relaunching Lagarde's empty proclamations from Davos – in which he provided an interesting and authoritative reading of the events since occurred here and, above all, the prospects for future actions by the ECB and the related consequences for the eurozone economy in the coming months.
Before reporting the most significant passages, the general impression one gets is that of a generalized prudence and less assertiveness compared to Lagarde's last rather "muscular" verbal statements. The difference between who masters the subject and who has to play the political role of barking at the moon, right or wrong.
Lane begins by dismantling the tiresome debate between demand-driven and supply-driven inflation , to which he replaces a more refined reasoning that does not stop at observing global imbalances, but goes into detail to observe individual imbalances at the sector level. It is undeniable that there has been a supply shock in the energy sector, but it is also true that in the goods sector there has been a post-Covid demand shock which has generated clear bottlenecks in international supply chains. This shock was followed by a demand shock in the services sector, coinciding with the reopenings.
He then goes on to reject the accusation that the current inflation has been caused by the excessively expansionary monetary policy of recent years, while underlining that, if the ECB had not quickly abandoned it starting from June 2022, that level of interest rates and liquidity would have further fueled the inflation triggered by imbalances in the real economy.
INFLATION AND THE RISKS OF RISING RATES
Faced with the risk that the ECB does too little to curb inflation or does too much, raising rates beyond what is necessary, Lane was very clear. This is not a risk of the coming months, but of the coming years. The current level of interest rates is not yet one in which there is a symmetrical risk of doing too much or doing too little. Today the ECB still risks much more not raising rates than raising them.
In any case – and this is where Lane's prudence emerges – the ECB assesses the situation every six weeks and an appropriate reassessment of the risks associated with rate increases is always possible. What matters is not so much making mistakes, but doing it for too long a period. So flexibility and timely adjustment guide the decisions of the ECB.
With regard to the differences between the US economy and that of the eurozone, Lane points out that – it is true that inflation in the eurozone is mainly caused by a shock in energy prices – but what the ECB must counter is the so-called of second impact”, which also brings inflationary pressures on wages and prices in all the other sectors of the economy. But the differences with the USA exist and make it necessary to increase rates in the Eurozone on a decidedly smaller scale than that taking place overseas. And this is a very important signal to understand that the level of interest rates in Europe will stop at a level lower than that of the USA. Furthermore, the risks mentioned by Lane, especially in Italy, appear limited, since the labor market does not appear so tense, to the point of allowing the success of the wage demands feared by Lane.
Faced with the question of what an equilibrium or neutral rate level could be, Lane argues that we have definitively abandoned the low inflation situation of the last decade and nominal rates will take this new scenario into account. We are facing structural changes in the forces that in the past helped to keep inflation low: globalisation, the recovery from the excess of private and public debt and public budget rigor are no longer at work, at least in part. Indeed, from now on, savers and investors will take into account an inflation premium in their investment and savings assessments. The final outcome of this recomposition of forces is subject to high uncertainty, but more and more determinants linked to individual economies will count than to globalisation. Despite having the years of low pre-lockdown inflation behind us, the current level of rates is not yet the one necessary to bring inflation back to 2%, but public budgets are also still in an expansionary phase and must return to normal, abandoning the fiscal stimuli in recent years for Covid and now for the energy crisis.
The stopping point of normalization is not definable because of the uncertainties, Lane continues. Just think of the sudden drop in the price of energy in the last 40 days. At the moment, the decision to raise rates further is sound and reasonable, but the last mile – bringing inflation to 2%, starting from a December 2023 forecast of 3.6% – is the most difficult. Above all because – and here Lane sows a huge doubt with great intellectual honesty – the mechanisms by which rate hikes actually affect inflation are also subject to considerable uncertainty. And therefore the most correct move is also to wait and observe the effects of the rate hikes already carried out on households and businesses, before moving further.
A NEW SPREAD CRISIS?
Regarding the risk of a repeat crisis of the spread like the one of 2011-2012, Lane points out that the wide divergences that characterized the economies of the Eurozone countries at the time have now almost completely disappeared. In addition, there is the procurement tool (TPI) which is ready to use "ex ante". So the risks of financial instability are reduced and Lane declares himself cautiously optimistic about the ECB's ability to manage the transition from "long low rates" to a new normal. Any recession will be mild and short-lived.
On the budgetary policy of the Member States – a sensitive issue for Italy – Lane once again talks about debt sustainability and the need to return to normalcy by avoiding excessive fiscal stimuli and austerity which slows down the economy. Lane does not miss the usual tirade against countries with excessive debt, for which there must be a framework of rules capable of guiding governments in the continuous and constant reduction of the debt/GDP ratio, in order to have space available in occasion of external shocks.
On the digital euro, Lane speaks in favor of the project, in particular that of the digital euro provided by the States, even if he has no intention of making it the dominant tool for making payments.
So far Lane and his vision of the state and prospects of the economy. It will obviously be possible to disagree or agree with respect to specific analyzes and evaluations. As mentioned at the beginning, we take a more cautious trait with respect to Lagarde's slogans and the "verbal fury" with which she has expressed herself in her latest releases.
Lane knows that deciding to accelerate trusting the good road conditions visible from the rearview mirror is an operation that can present risks. It's not wise to show up around a corner or in front of a wall at high speed.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/bce-philip-lane/ on Mon, 23 Jan 2023 06:25:16 +0000.