Europe fails to fight inflation
Juan Pedro Marin-Arrese | Blaming Putin for the current inflationary fight no longer holds. No one disputes that the sanctions aimed at crippling the Russian economy following the aggression against Ukraine have caused the prices of vital inputs to skyrocket, mainly due to wild speculative movements. Today, we are witnessing sharp falls in commodities as prices accelerate. So, to claim that we only face a cost shock from these products seems dubious. It sounds like a useful excuse for decision-makers trying to shirk responsibility for a problem they feel unable to solve.
The truth is that we are already plunging into second-round inflation fueled by expectations. Companies are factoring in future cost increases by raising their current selling prices, while workers fearing a significant drop in their real earnings are pushing for higher wages. Citizens and governments refuse to acknowledge that the new perspective has impoverished them. They continue to execute unsustainable levels of spending financed either by debt or by the divestment of accumulated savings strengthened during the pandemic. Because overspending is the ultimate driver of inflation. Putin may have fired the shot, but such a long and accelerated fire only stems from robust demand ready to buy at ever-higher prices.
Monetary policy across the Atlantic is rapidly moving towards a restrictive stance. American policymakers are taking the threat seriously, while their European counterparts prefer to ignore the bleak outlook ahead. The European Central Bank is still struggling to abandon its largely accommodative policy. As soon as it announced its intention to close the asset purchase facility, fears that the fall of the sovereigns of highly indebted countries would lead to total collapse in Italy and Spain forced the ECB to backtrack. Markets are pricing in a meager first round quarter point rate hike this month. Meanwhile, the Federal Reserve will make another substantial hike, the fourth in a row, targeting a level close to 4% by the end of the year. A revealing difference between the Fed’s desire to reduce demand and the benign negligence displayed by the ECB.
Fiscal policy also reflects such a contrast. While Janet Yellen of the US Treasury devotes considerable efforts to controlling public spending, Brussels is extending the free ride on deficits for another year. No wonder many European leaders are betting on massive spending to mitigate the side effects of rising prices. Some, like Prime Minister Sánchez in Spain, plan to sharply increase both revenue and spending, in a bid to bring public accounts into line. They ignore that increased spending, even coupled with corresponding higher taxes, inevitably leads to economic overheating.
Some believe that the threat of a potential recession in Europe justifies ignoring current inflation. They forget that price increases seriously undermine and disrupt economic performance, increasing the risk of a downturn. Christine Lagarde rightly pointed out that the increase in tariffs will not lower gasoline prices. However, this conclusion no longer holds in the face of generalized inflation. As Prime Minister Sánchez’s position suggests, keeping spending and debt high is a dangerous bet. Even if Brussels approves its policy, the markets could soon pay the price.