It's Hard to Get Good Help: The Case of the European Central Bank

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Monday, 31 March 2014 06:51

Many economists have difficulties with simple arithmetic. That is why so many of them failed to recognize the rising and unsustainable ratios of house prices to rent and income. Apparently arithmetic problems still figure large in policy at the European Central Bank (ECB).

The NYT noted a slightly lower than expected inflation measure for February and told readers:

"The ECB, which targets inflation of just below 2 percent, left borrowing costs unchanged at 0.25 percent in March and has argued that deflation risks in the bloc are limited.

"ECB President Mario Draghi suggested after the ECB's March meeting that the bank will either do nothing or take bold action should the outlook deteriorate.

"He has also said the bank has been preparing additional policy steps to guard against possible deflation, and that the longer inflation remained low, the higher was the probability of deflationary risks emerging."

Of course those familiar with economics and arithmetic know that there is no special problem associated with deflation. The problem is a lower than desired inflation rate. This makes the real interest (the nominal interest rate minus the inflation rate) higher than desired and it also means that debt burdens will be more difficult to bear, since the debtors were anticipating a higher rate of inflation. It also means that it will be more difficult for peripheral countries like Spain, Italy, and Greece to restore their competitiveness within the euro zone since they will have to see actual price decline if they are to improve their position relative to countries like Germany with very low inflation rates.

But these issues do not change when the inflation rate crosses zero. The drop from 0.5 percent inflation to 0.5 percent deflation is no worse than the drop from 1.5 percent inflation to 0.5 percent inflation. People who know economics understand this simple point. Apparently the shortage of skilled workers is hitting the ECB.