Inflation: monetary policy at a snail's pace

History does not repeat itself, but we can still learn from it.

Arab producing countries reacted to the Yom Kippur War in 1973 by quadrupling the price of oil, which led to a crisis in western industrial nations.

Germany in particular was dependent on Arab oil at the time.

The rise in the price of the commodity hit Western economies, which were confronted with an unfortunate combination of rising inflation rates and weak economic growth after the collapse of the Bretton Woods global economic system.

Such a situation is like a nightmare for monetary policy.

Central banks cannot do anything directly to counteract the rise in the price of commodities.

It's the same today as it was then.

But central banks have it in their hands to prevent the overall price level from rising in the medium and long term.

This requires rising interest rates;

Of course, such a monetary policy threatens to seriously damage an already fragile economic growth.

The central banks find themselves in this conflict of goals today as they did then.

What can be learned from these experiences?

At the time, the Deutsche Bundesbank reacted, with a pleasing comment by the then social-liberal federal government, with a tough policy that sent Germany's economy into a brief recession, but brought the inflation rate under control more quickly by international comparison.

At the time, the Bundesbank was unable to prevent a temporary increase in the inflation rate to 7 percent, but the rate soon fell again.

In other countries, the central banks shied away from taking similarly tough steps in order to damage economic growth as little as possible.

In return, they reaped peak inflation rates of 23 percent in Japan, 19 percent in Italy and 16 percent in Great Britain.

What can be learned from these experiences?

Even if economists who were well-meaning at the Bundesbank thought afterwards that the Frankfurt monetary watchdogs might have acted a little harshly at the time, the Bundesbank's fundamental approach is considered correct: inflation must be combated early and visibly.

The other countries that allowed high rates of inflation failed to mitigate the damage to their economies in the medium and long term.

The Federal Republic came through the difficult 1970s better economically than many partner countries.

The European Central Bank is now in an even more difficult situation than the Bundesbank was half a century ago.

The war in the East is not over;

its political, military and economic consequences remain unforeseeable.

The economy in the euro zone appears more fragile than the economy in the Federal Republic of Germany in 1973. And finally, in view of the very large, globally networked financial markets and the high level of indebtedness of numerous countries and companies, central banks today have to deal with the consequences of monetary policy decisions for stability to a far greater extent than in the past of the international financial system.

And yet the Bundesbank's old approach remains correct: inflation must be combated early and visibly – especially in a world characterized by great uncertainty.

The European Central Bank announced cautious steps on Thursday, preparing for a cessation of its bond purchases in the summer and interest rate hikes in the second half of the year.

While a few frightened souls in the financial markets and in the economists' study consider these cautious steps to be too bold, the conclusion remains: It is very likely that the central bank is moving too slowly.

Uninvited permanent guest

After the ECB has consistently underestimated inflation in its forecasts in the recent past, this fatality threatens to continue.

Although she now expects an inflation rate of at least 5 percent for the current year, she assumes that the rate of inflation will fall to the medium-term target of 2 percent in the coming years.

This medium-term prognosis is unlikely to last long.

Soaring energy prices are propagated throughout the economy over time.

The longer the current surge in inflation lasts, the more people will expect high inflation rates in the longer term.

But once the expectation of inflation solidifies as a permanent phenomenon, noticeably higher wage settlements will naturally follow, which in turn will fuel inflation again.

The ECB cannot influence oil and gas prices, but it can and must prevent inflation from becoming an uninvited permanent guest in the eurozone.