Insight
Europe shouldn’t worry about inflation by Christian Odendahl 20 July 2021
The fear of inflation is stalking Europe again. Policy-makers are right to be relaxed. Inflation is no near-extinct tortoise that suddenly reappears unprompted. Nor is it a short-term fluctuation in the prices of certain goods and services during a disruptive pandemic. Inflation is a general rise in the level of prices in response to underlying economic forces such as employment, growth, the economic expectations of people, and policy-makers’ actions. For central bankers, inflation is a useful thermometer for the economy: if it is too low, it points to a cool economy that has unused capital or labour that can be put to use; if it is too high, it shows that demand is higher than capacity, which drives up prices too fast. A steady and predictable inflation of 2 per cent is ideal for Europe. Europe’s problem over the last decade has been a cool economy: too little inflation pointed to an economy that was running below its potential. Policy-makers seemed unable (though mostly, just unwilling) to generate enough demand to bring the European economy back to its potential, and inflation back to a healthy 2 per cent. As Europe is exiting the pandemic, it is crucial that policy-makers do not choke off the economic recovery out of a misplaced fear of inflation. In fact, a period of above-target inflation would be helpful to make sure that the economy really has fully recovered and that all capital and workers are employed. But pushing the European economy sustainably out of its low inflation mode of the last decade towards rates above 2 per cent is not easy. Of the five ingredients that are needed to achieve sustained inflation, Europe currently has none. Ingredient 1: Overstimulate your economy In the US, the Biden administration quickly got to work after the inauguration and announced major spending plans. The most important was the ‘Rescue Plan’ of $1.9 trillion, which sent $1,400 checks to individuals (and their children) earning less than $75,000 per year, extended child tax credits and ‘earned income’ tax credits, and extended an uplift in unemployment benefits. In particular, those in the bottom half of all income earners were given a sizeable boost to their take-home income, with those in CER INSIGHT: Europe shouldn’t worry about inflation 20 JULY 2021
info@cer.EU | WWW.CER.EU
1