Against inflation: Monetary policy must set an example

For months, experts have been arguing over the question of whether the current price surge is a temporary phenomenon or heralds the beginning of an era of higher inflation rates.

Precursors from post-war history can be found for both scenarios: When the inflation rate in Germany jumped to 7 percent in the course of the Korean War in 1951, some contemporaries saw the end of the only three-year-old D-Mark approaching.

Inflation remained as an episode back then as it did in the early 1990s, when it briefly hit the 5 percent mark, driven by the boom in reunification.

The initially leisurely rise in the price level at the end of the 1960s, however, turned out to be a harbinger of a period of more than ten years of above-average inflation rates.

Fighting inflation does not come for free

The question of whether inflation will remain a short-term phenomenon or become a longer-term nuisance depends largely on the behavior of the central banks.

Monetary policy is not in a position to block a short-term rise in the level of consumer prices, as is currently caused by the rise in the price of raw materials and disruptions in world trade.

With its instruments, however, it can very well prevent a one-off price surge from turning into a permanent phenomenon.

However, experience also teaches that combating inflation, for example by ending bond purchases and increasing key interest rates, can damage economic growth as a side effect by making financing more expensive for states, companies and private households.

Fighting inflation does not come for free.

At a time when globalization is stalling, the economic consequences of the pandemic are difficult to calculate and ambitious climate policy will cost a lot of money, some central banks have consoled themselves for a long time with the conviction that current inflation does not require monetary policy action.

Numerous economists share this analysis.

Last but not least, the European Central Bank takes this position, but it is no longer undisputed in monetary policy either.

The camp of those who oppose the thesis of the only temporary nature of inflation received a prominent entry on Tuesday with Jerome Powell: The chairman of the American Federal Reserve is the most powerful monetary politician in the world.

The self-image of the central banks has changed dramatically in the past few decades.

For several decades they were so successful in the fight against inflation that they looked for other occupations.

In severe economic and financial crises, they have established themselves as insurers against major macroeconomic risks.

The price for this is growing reliance on governments and financial markets.

The central banks are also more publicly interested in seeing themselves as fighters against climate change or against growing inequality of income.

In doing so, they raise questions about the limits of the power of unelected bureaucrats.

There is a need for a sign

So far, they have not had to pass the test of whether the new style central banks will show the same consistency as their predecessors in fighting inflation.

But you will probably not be able to evade this test.

For a central insight formulated almost exactly a hundred years ago by the British economist John Maynard Keynes has not changed: the greatest damage caused by deflation is its destructive power to economic prosperity.

The greatest harm of inflation, in turn, lies in its unjust and antisocial effects on the distribution of income and wealth.

Inflation puts the poorer strata of the population at a disadvantage compared to the wealthy because the poorer are hit harder by the loss of purchasing power in everyday life.

There is no other option than a stability-oriented monetary policy to combat the adverse effects of inflation.

Government controls on wages and prices have not proven their worth in North America as in Europe.

The national budgets of many countries are so tight that financial compensation for citizens to compensate for the loss of purchasing power suffered by inflation would be an illusion.

The current rate of inflation is high, but the foreseeable dangers for the years to come are not so dramatic that they have required drastic central bank action.

But it is time to take a stand to demonstrate the determination of monetary policy.

Such signs are to be expected in a short time from the Federal Reserve and the Bank of England.

The European Central Bank shouldn't hesitate any longer.