MLC investment strategist Brian Parker gives a historical perspective to the dilemmas presently facing the European Central Bank (ECB) and finds price stability at the core.
The US Federal Reserve operates under a dual mandate to both support economic growth as well as promote price stability (or in other words, low inflation).
This dual mandate is an explicit acknowledgement of the worst disaster to befall the US economy in the last century, the Great Depression, and the enormous economic and social costs endured over nearly a decade.
In a sense, the ECB’s explicit price stability mandate is built out of a German rather than a Europe-wide historical perspective.
The German hyperinflation of the late 1920s and the collapse of the Weimar Republic rated more highly than the Depression years in the psyche of the German people when it came to building their key policymaking institutions after World War Two.
The Bundesbank emerged from that period with a fierce independence and a relentless pursuit of price stability.
Given the hyperinflation experience, the idea of a new German central bank funding any budget deficit by “printing money” – ie buying Government bonds and allowing the Government to write central bank cheques on the proceeds – was utterly rejected.
When it came time for a new central bank for the Euro-area, the European Central Bank was imbued with the same beliefs and operating instructions as the Bundesbank, including the bit about not printing money to fund budget deficits.
In other words, the ghosts of Europe’s, or rather Germany’s economic past, haunt the corridors of the ECB as surely as they did the Bundesbank. Under normal circumstances, that’s just fine.
But these are not normal circumstances. Europe – especially those countries on the periphery of the Euro zone – are in much more danger of re-living US economic history at this point than that of Germany.
The ECB is the only institution in Europe with the credibility and firepower to act as the lender of last resort to European Governments and financial institutions when debt defaults inevitably occur in Europe.
While Europe’s governing law precludes the ECB from buying Government Bonds directly from national treasuries, it does not appear to preclude them from buying those bonds in potentially unlimited quantities on the open market.
The economic and social consequences of not doing so when the time (inevitably?) comes could be catastrophic.
Why wouldn’t they do this? Concerns about moral hazard are ridiculous in the face of economic depression and massive social unrest, as are historical fears of “hyperinflation” when economic conditions are so utterly dire.
Worrying about inflation in Europe right now is like a general trying to fight not just the next war, but two wars after that.
Maybe having an Italian in charge of an institution with such a peculiar German heritage is just what is needed at a time like this.
Brian Parker is an investment strategist at MLC
