Expert Commentary

The ECB's Slope of Hope to Deflation

Denial ain’t just a river in Africa. It also flows through Belgium.

Yesterday saw the release of updated macroeconomic forecasts from the European Central Bank. In the dynamically titled, “Eurosystem staff macroeconomic projections for the euro area, December 2020,” the outlook for price inflation was stated.

“As regards inflation, upward base effects associated with the earlier slump in oil prices and upward impacts from the reversal of the VAT rate cut in Germany imply a rebound in headline inflation in 2021. HICP inflation excluding energy and food is expected to show a much more muted recovery in 2021 as broad-based disinflationary effects from weak demand, especially across the services sectors, dominate upward cost pressures from supply side constraints. Over the medium-term headline inflation is expected to gradually increase, mainly reflecting a slight rise in the contribution of HICP inflation excluding energy and food which, however, is seen to remain rather subdued, at 1.2%, in 2023. Overall, the baseline foresees HICP inflation rebounding from 0.2% in 2020 to 1.0% in 2021 and then gradually increasing further to 1.1% in 2022 and 1.4% in 2023.”


As Albert Einstein didn’t say in one of the most misattributed quotes of all time, "Insanity is doing the same thing over and over again and expecting different results.” It’s still a good line, though, and fits perfectly with the European Central Bank’s fixation with price inflation. As the chart below shows, since 2010 the ECB has consistently expected price inflation to be higher than it turned out to be. As price inflation has decelerated over the past decade, the ECB has continuously hoped that it would reverse. You might think that someone in the “staff” would say “look guys, there’s obviously something going on here that we’re not getting.” Alas, bureaucratic institutions are structurally inclined to group-think and so the chances of the ECB taking its blinkers off about price inflation are almost non-existent.

The problem is that the ECB, as with central banks around the world, have dug this mammoth hole for themselves where they are beholden to targeting price inflation. It could be a ruse, enabling them to declare price deflation the enemy and constantly increase the money supply, helping to finance government debt and increase the size of the state. Or it could be that they really don’t understand what’s going on at all but can’t stop doing what they’re doing because of denial and the inability to admit to it as a mistaken policy.

We’re not holding our breath for that. If Japan’s the model that Europe’s following, there is much more stagnation to come.

European Union Core Harmonized Index of Consumer Prices DEC 2020