German Inflation

April 28, 2009

German consumer prices rose marginally on a seasonally adjusted basis in April and by 0.7% from a year earlier.  The 12-month advance was above March’s 0.5% but below February’s 1.0%.  The April results were about as expected but clearly below the ECB’s definition of stable prices being synonymous with a 12-month increase of less than but close to 2.0%.  Germany has been experiencing only slightly less inflation than Euroland as a whole.  Germany does not have the lowest inflation in the bloc.  Spanish inflation and Portuguese inflation are already negative, and the pace is below 1% in France and Belgium.  German consumer prices fell around 0.6% at a seasonally adjusted annualized rate over the past half-year, and price risks in Euroland’s biggest economy are biased to the downside because of a very weak growth outlook.  The government in Berlin reportedly will revise its 2009 GDP forecast to negative 6% tomorrow.  The IMF projects declines in Euroland real GDP of 4.2% this year followed by 0.4% in 2010.  Given its size and proximity to full-Euroland trends, Germany is not an unreasonable proxy upon which to base monetary policy for Euroland as a whole.  Germany’s size is not a bad fit for Euroland, and Germany clearly needs looser credit policy.

The ECB Governing Council’s key 1.25% refinancing interest rate has never been lower, but policymakers were more vigilant when raising rates in earlier years than they have been in loosening policy more recently.  This institutional bias can be observed in the guiding role of expected inflation.  When actual inflation crept higher, rates were raised to ensure that steady expected medium-term inflation remains stable.   Policy was preventive, not reactive.  But since inflation has been declining, resistance to cutting the refinancing rate to less than 1% and to implementing aggressive forms of quantitative easing have been justified by the steadiness and in-target nature of expected inflation.  One does not hear officials argue that significantly lower-than-target actual inflation raises the probability that expected inflation will drift too low.  Even though expected inflation is still consistent with the notion of stable prices, it is the job of forward-looking monetary policy to ensure that it remains so.  If policy isn’t eased until measures of expected inflation decline, the goal will have been already lost.

Continental Europe’s legacy is the post-World War I hyperinflation, which wiped out the real value of lifetime savings.  America’s legacy is the deflation of the 1930’s, which amplified the intensity and pain of the depression.  Different cultural legacies endow ECB and Fed monetary policies with different worst-case scenarios and different answers to the critical question that asks what worst-imaginable outcome must be avoided at all costs.  Sky-rocketing fiscal deficit spending has strengthened the resolve of ECB hawks against a gamble on an ultra-loose credit policy.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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