Home > Uncategorized > The ECB: still behind the curve when it comes to (estimating) inflation. Graph

The ECB: still behind the curve when it comes to (estimating) inflation. Graph

Up to about 2011 the ECB largely disregarded the systemic risks inherent in the private ‘printing’ of trillions upon trillions of Euro’s and the connected exponential rise of private debt. These increases were caused by ever more generous lending for house purchase, a process spelled out clearly and on a monthly basis by the ECB’s own monetary statistics. These statistics were extended backwards in the important article “LONG-TERM DEVELOPMENTS IN MFI LOANS TO HOUSEHOLDS IN THE EURO AREA: MAIN PATTERNS AND DETERMINANTS” in the Monthly Bulletin of October 2007, which showed that the rise already dated from the eighties. But instead of leading to a heightened sense of alarm this information only led the ECB to state:

assessing the historical pattern of household loan developments purely on the basis of the macroeconomic determinants of loan demand remains to some extent inconclusive, given that loan developments over the past two decades are also likely to reflect a number of structural influences, such as financial innovation and changes in mortgage market regulation, as well as the shift to a low-inflation and credible monetary policy environment in the euro area in the context of EMU”

Translated: deregulated capital markets do lead to rogue lending, but that’s because of us, so, no problem. Again: October 2007.

Runaway ‘lending for house purchase’ enabled and to an extent also caused double-digit house prices increases in quite a number of Eurozone countries. And the ECB missed out on those, too. Why? I mean – the ECB is supposed to guarantee stable and low average inflation, which becomes kind of hard when you do not pay attention to one of the two or three most important prices in the economy at the very moment when billions upon billions of new money are fuelling double-digit increases of this price (another of the most important prices is of course the price of labour). Why didn’t the ECB take these double-digit increases as well as the increase of debts and the amount of money more serious?

One of the reasons for this obvious failure, arguably inspired by rational expectation economics, was the ECB’s obsession with targetting only one particular metric of one particular kind of inflation, i.e. the year on year change of the Harmonized Index of Consumer Prices (HICP). The idea, repeated ad nauseam by ECB officials and fully consistent with rational expectation economics, is that if only HICP inflation remains a little below 2% in the medium run, if necessary by increasing interest rates to an economy wrecking  ‘whatever it takes’ level,  the ECB will remain ‘credible’ which, in its turn, will lead to the hitting of the target and prevention of monetary turmoil. To quote Robert Lucas (September 2007!):

In the past 50 years, there have been two macroeconomic policy changes in the United States that have really mattered. One of these was the supply-side reduction in marginal tax rates, initiated after Ronald Reagan was elected president in 1980 and continued and extended during the current administration. The other was the advent of “inflation targeting,” which is the term I prefer for a monetary policy focused on inflation-control to the exclusion of other objectives. As a result of these changes, steady GDP growth, low unemployment rates and low inflation rates — once thought to be an impossible combination – have been a reality in the U.S. for more than 20 years….

Well, live intervened. And Lucas is (like an economists like Thomas Sargent) talking about consumer price inflation. The important words however: “to the exclusion”. “Don’t mind financial instability, unemployment or whatever – just target consumer price inflation”. Sounds familiar, doesn’t it? But when we look at a more complete set of inflation metrics, like those of the national accounts which do not only track consumption prices but among other variables also investment prices as well the prices of government consumption (to a large extent wages of teachers, soldiers, whatever) it turns out that especially after 2008 inflation rates in different sectors of the economy show non-trivial differences. And at this moment broad inflation (measured with the GDP deflator) has been quite a bit below HICP inflation for four years in a stretch.


Which for instance means that real interest rates have been quite a bit higher than often assumed while monetary policy has been much tighter than often assumed. Consumer price inflation is not a dependable proxy of the inflation of the general price level. But the ECB is still targeting it…

Which of course leads to the question if the ECB is changing its ways – they’ve had more than four years to learn. And other institutions did learn. The statisticians of Eurostat did. They are rapidly improving their house price statistics as well as publishing dependable and ever more sophisticated variants of HICP inflation (core inflation, constant tax rate inflation) ever faster. The economists of the European Commission did. They are already using these new metrics to investigate  ‘financial fragility‘. They are in fact doing what the ECB should have done a long time ago – but what the ECB didn’t do as it listened  to Robert Lucas and his like. But the ECB still seems very reluctant to learn. In an ‘opinion‘ on the new Eurostat statistics it grudgingly admits that they can’t stop this new developments, though it wasn’t their idea (Draghi however does use some of these data in his speeches):

The ECB supports the objectives of the proposed regulations related to: (a) the establishment, through the proposed HICP-CT regulation, of the regular production of harmonised indices of consumer prices at constant tax rates and … (b) the compilation, pursuant to the proposed OOH regulation, of price indices for dwellings and for housing expenditures incurred by owner-occupiers…

This less than enthusiastic endorsement is followed by two pages of outright childish bureaucratic infighting and bickering of the ‘you didn’t tell me and now I’m hurt’ kind, which is, rather unusually, translated in no less than twenty languages. Which shows the importance which the ECB attaches to this opinion. But which also shows that the ECB still hasn’t learned. And does not want to learn. And still bases its policies on the wrong metrics. And wrong economics. Incredible.

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