Why Would the ECB Create Inflation by Printing Money, and Why Would That Be Bad?

In a column noting the bind in which the euro zone countries fund themselves, Robert Samuelson told readers that:

"Softening today’s austerity would require more borrowing. Who would lend? The ECB? Historically, excessive lending by central banks risks high inflation, though many economists discount that now."

Given the massive amounts of excess capacity in the euro zone it is difficult to see how additional lending in the euro zone would lead to inflation. The context in which central bank lending led to inflation has typically been when an economy was near its capacity and a central bank continued to lend to keep interest rates down. That is clearly not the situation today.

Furthermore, the euro zone countries should welcome a modest increase in the rate of inflation. The key problem facing the euro zone is the uncompetitiveness of the peripheral economies. The cost of goods and services produced in Spain and Italy is much higher than the goods and services produced in Germany and the Netherlands.

If the euro survives, this gap has to be closed by having lower inflation in the peripheral countries. That would mean deflation if the inflation rate remains low in the core countries. Deflation is very difficult to bring about and will be very costly for the economies affected.

On the other hand, if inflation rises to 4-5 percent in the core countries, then the peripheral countries can regain competitiveness by keeping their inflation rate in a 1-2 percent range. This would be the most painless solution to the euro crisis. Unfortunately, the European Central Bank seems unable to even conceive of this policy path.

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written by skeptonomist, June 04, 2012 8:34

A scenario in which Germany has inflation in the 4-5% range while the peripheral countries are only inflating at 1-2% is extremely unrealistic. A major reason that the latter wanted to have a currency union is to control their inflation. There is no reason to think that the ECB, even if it were run by Paul Krugman or other monetary-policy experts, would be able to fine-tune the inflation in the individual countries. Obviously the central banks in the pre-union Europe were not able to control their own inflation.

Germany's trade position has gained over the last 10 years partly because its wages have risen very little in comparison to those in the peripheral countries, so one solution would be to allow wages to rise in Germany. It would not be painless - the reduced German trade would take a bite out of someone, and this would certainly be opposed by German capitalists.

-2

why?
written by Peter K., June 04, 2012 1:05

"There is no reason to think that the ECB, even if it were run by Paul Krugman or other monetary-policy experts, would be able to fine-tune the inflation in the individual countries. "

Why do you think this? There seems to be number of Internet comments who have a weird desire to downplay the efficacy of inflation and monetary policy. Again, why?

Samuelson: "Historically, excessive lending by central banks risks high inflation,"

well for 4 years inflationistas like Samuelson have been invoking the bond vigilantes and yet 10 year Treasuries just hit record lows. The market doesn't doubt the Fed's desire to combat inflation. Hopefully the inflationistas are losing money on their poor economic forecasting.

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written by Dan, June 04, 2012 4:18

Consistent with Baker, Krugman explains it pretty well.

http://krugman.blogs.nytimes.com/2011/01/18/european-inflation-targets/

Why, oh why?
written by David, June 04, 2012 6:39

Top 10 reasons the ECB is unable to conceive of this path:

10. German bankers hate to get their hair cut.
9. Deutsche bank won't hire Draghi as a consultant after his tenure otherwise.
8. That page is missing from "Ethics of the Rich and Famous."
7. Let them eat cake.
6. College graduates should start businesses, just like every trust-fund baby has done for them.
5. This is banking, not reality, ok?
4. "We can't break the law unless it's in our biggest customers' interest."
3. If you're gonna fail, fail big.
2. The ECB can thus serve as a warning for future generations to ignore, just as the ECB has ignored history.

And, of course, the real reason:
1. "But then we'd have to admit Krugman and Baker were in large part correct!"
("KRUUUGGGGGMMAAANNNNNNN!!!!!" @#!%#@!!!)

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written by Scott.Z, June 05, 2012 7:17

This seems to be the problems everywhere, "The cost of goods and services produced in Spain and Italy is much higher than the goods and services produced in Germany and the Netherlands" really tells the tale here. There is so much going on with the economy that there doesn't seem to be a really good way out, it seems that nothing works at all.

There are so many people who love the idea of controlling others by providing the website technology they need but it has been proven that this type of economy doesn't work.

Hmmmm
written by James, June 05, 2012 9:04

Look Professor it's like this...

If your creditors see the massive devaluation and reject the currency; then you can get into the death spiral of having to print more and more money to keep up with basic social spending. Europe's productivity sans Germany is already fantastically low. Hence it's probable the world starts rejecting euro-bonds that do not guard against inflation. Consequently, productive activity and wages will possibly drop along with purchasing power going down. Rather quickly you can have the situation where you have zero real economic activity except among the bankers who will hedge themselves.

So, the PIIGS problem will snowball.

It's just another new currency that a bunch of socialist governments have ruined in Europe. A big part of the boom was Europe having a fresh pile of new money. Like all the socialists, you guys need to hit the forget button and wipe your memory of another failure.

Devaluing is a solution that works till it doesn't. The debt created enriches the bankers and doesn't address the underlying issue. The issue is the countries are bankrupt again.

Or you can limp along going further into the hole for another decade...

Why Would the ECB Create Inflation by Printing Money, and Why Would That Be Bad?

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