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Economy in Brief

French Inflation Cools As the ECB Target Runs Hotter
by Robert Brusca  July 13, 2021

Inflation in France in June ticked up by 0.1%, according to the 'official' HICP gauge. The last three months are a picture of price stability at 0.1%, 0.3%, and 0.1%. It produces a very slightly above target pace of 2% (above ECB all-EMU target rate, that is…). There are not country by country targets but we can speak of nation's inflation rate as being hot or cold vs. the pace the ECB sets for the whole of the regions. French inflation on such lexicon is in very good shape and only slightly 'hot.' In fact, if we dig deeper to look at the domestic index, inflation is running 'cool' at a 1.7% pace. And in that index, if we eliminate energy, the domestic CPI less energy runs at a three-month pace of only 1%. Andd that is quite cool.

Voldemort and inflation
Short-time horizons can be used to vet 'inflation pressures.' But typically central bankers only look at the year-on-year pace since these are more stable, less prone to the exaggerations of compounding and simply less volatile. The definition of inflation has no timeline; it is simply an ongoing increase in the price level. 'Inflation' has no speed; it has no time dimension. But central bankers adopt their own notions to this general definition. They prefer year-on-year trends but pay a price for this stability: annual inflation rates are laggards. They are the result of the changes in the price index in each of the previous 12 months. It seems a shame to let so much data go to waste to focus only on the 12-month change. And certainly central bankers are aware of those 12-months and aware of the three-month and six-month inflation rates they just like in Harry Potter movie agree to never speak their names out loud (the changes that cannot be named!).

For France right now these sequential inflation rates are pretty much flat, subdued and close enough to the actual new objective that French inflation seems to be 'compliant' with ECB policy.

New shoes for central bankers: one size fits none?
ECB policy has changed. It used to shoot at a target expressed as 'close to but slightly below 2%.' Now if seeks to achieve 2% inflation on average. This change could amount to very little or a lot. As always in policy interpretation is everything; fact amounts to almost nothing-facts can be dismissed (…this is temporary, that is distorted and so on) in monetary policy opinion trumps fact like rock smashes scissors.

The best recent example is from the Fed in the U.S. that, in 2015, despite an ongoing and massive target undershoot 'claimed to see' 2% inflation in the medium term and began to hike rates with inflation well below its target rate. Meanwhile by end-2018 the Fed had orchestrated a series of rate hikes and the 2% objective had been rarely been achieved on the period. Some had viewed this as a Fed 'masterstroke' of policy to hike rates even in the face of withering inflation to get the Fed funds rate up off the zero bound. That was until the economy began to weaken and even ahead of the Covid crisis the Fed cut rates sharply. Now with inflation in the U.S. cooking, the Fed again has a vision of the future that allows it to ignore reality. Because of its past transgression in misinterpreting the future and ignoring the present, it is going to risk repeating that same mistake to make sure it does not once again raise rates too soon. The Fed is now determined to make the opposite mistake.

The relevance of these events to the ECB is that the ECB is on the same path now as the Fed. The ECB was formed in the image and likeness of the Bundesbank to create a rock sold low enduring rate of inflation with nearly automatic rate hikes that would remove any chance for discretion to intervene. The 2% 'ceiling' (I will use this terminology in lieu of the wordier more correct expression cited previously) meant that inflation at or above 2% instantly was excessive. And for a central bank with only one objective it put monetary policy on a hair-trigger. That had not seemed like a bad idea in Germany where hyperinflation once ran free. In fact, it seemed more a prudent preemptory action. But in the rest of Europe, this became a bitter pill and one that was swallowed too often with ill effect especially through the Great Recession period and the austerity that engendered. So after that experience and once Covid struck the forces on the ECB no longer tilted toward its former Teutonic goals. The inflation crushers had played their hand too inflexibly and, like the Fed, having done that once were not going to be allowed to do it again. The more moderate factions on the ECB engineered a 'similar' but softer version of the old rule as a result. The hard money Germans, Austrians, Dutch and others were out-voted and it is not surprising that a new more flexible target emerged from the ECB's policy review. This now makes the ECB are more indirect descendent of the Bundesbank- more like a half-brother than its spitting image, as had been intended. Shooting at an average allows all sorts of flexibility especially given the broad undershooting of the past. Average over which period? Ah… that's the rub…rub-a-dub-dub.

Both the Fed in the U.S. and ECB in Europe find themselves making versions of policy that seem peculiar given their past. Although it is only because of their recent past that they find themselves in these respective woodsheds. Is the policy each running really a 'punishment' for bad policy in the past? Or do these central banks really believe that current policy as constructed really is optimal? I don't know that we can tell. In the case of the Fed in seven years unredacted true FOMC meeting minutes will be available and, maybe under the cover of a seven-year veil, the policy discussion as recorded will be frank and we will know.

Despite this modification in the ECB's policy target, it does seem that that the hard money types have won. Inflation is Europe is low and it is low everywhere not just in the EMU because of a large weight for low-inflation Germany amid more inflation elsewhere. But it took the Great Recession and that spate of austerity that created the Great Transition of policy in the EMU. Still, policy differences bubble below the surface. Maastricht rules regarding fiscal policy have been set aside and when 'this is all over' there will be a day (decade?) of reckoning. It is far from clear how that will go or if the Maastricht parameters might be altered as the ECB's policy target was altered.

And the future? Lies ahead- is that all we know about it?
As always, the future lies ahead. We can try to predict it based on the past-what else do we have to go on? But the past can be interpreted in so many ways. As we see above, the Bundesbank to ECB transition was seamless. But the ECB had a different constituency and when the hard money crowd in the EMU-area played their cards too strictly there was a blow up and now new rules? It is a sort of catastrophe theory version of things in which imbalances build and nothing seems to happen until there is a rupture then there is a massive change.

This sort of admission leaves us less confident about forecasting. And it is not just theoretical as we have seen both the Fed and the ECB succumb to pressures in this sort of process where they employed denial to continue on their path until it was construed as excessive and change was forced upon them. We can't even be sure that these new policy processes won't create their own excesses and push us back where we once were with policy. Covid has changed the world and caused us to do things we would not have done in the absence of Covid. It is unclear if some of the experimental things that have been done will now become common practice or if firms will successfully be able to put the toothpaste back in the tube and return substantially to their old ways of doing business. And the jury is still out on what works best.

Christine and Jerome in Opinion-land
Whatever happens, the period ahead appears to be ready for some rough sledding. Making policy in this environment will be difficult. It is not clear if the new looseness in policy is the right approach in the wake of all this dislocation with the vast stimulus that has accompanied it. We are very much less in science-land and more in opinion-land. One of the problems that must be faced up to is that so much 'money' was wasted in the helter-skelter spread of stimulus while so many deserving people were, at the same time, either ignored or undercompensated. Capitalist economies were not set to deal with such displacement. It has to make us wonder if the policy response was the right one and if those in charge of making decisions considered a broad enough set of factors while sacrificing so much to 'stop the spread.' And as we turn to the future, how will those policy choices of the past affect policy and politics in the period ahead? Covid seems not just to have infected us, and killed some of us, but to have divided us as well.

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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