Inflation fears

How real is the risk of inflation in the eurozone? Opinions vary widely.

Some experts worry that the various measures, such as the 750-billion-euro rescue package and the proposed new financial regulations, could lead to greater instability and thus fuel inflation. Others say the European Central Bank (ECB) has a firm handle on inflation.

German Central Bank president Axel Weber, for instance, argues that the ECB is fully committed to controlling inflation in the eurozone. “The euro system will not budge a centimeter from its goal of maintaining price stability,” said Weber, a member of the ECB governing council, at a budget hearing in German parliament on May 19. Even during these difficult times, he said, the ECB promises to ensure price stability.

Concerns of ECB losing its independence

The ECB was sharply criticized for its controversial decision to purchase bonds from eurozone countries struggling with debt. Weber was among the critics. Many voiced concerns about the ECB losing its independence from European policymakers.

The employer-friendly Institute of German Business (IW) in Cologne maintains that European central bankers are well armed to fight inflation; it also doesn't expect prices to explode anytime soon. “Those who come up with all kinds of horror inflation scenarios are basically saying they don't trust the European Central Bank and its leaders,” IW director Michael Huether said on May 17.

Huether said he can't imagine the ECB raising its inflation target. The bank, he noted, views prices as stable when inflation is just under 2 percent – a level Huether believes is realistic for the next few years.

No need to swing the "interest rate bat"

Combating inflation isn't a technical problem, according to Huether. The ECB has sufficient instruments at its disposal and has already sent a signal to the banking community that it will use all of them to fight inflation, if necessary. The central bank doesn't have to come out “swinging its interest rate bat,” the IW director added. Instead, he believes, it can control inflation through liquidity in the market.

Gustav Horn, director of the Institute for Macroeconomics and Economic Research (IMK), has his own opinion about liquidity. “The key question is if and how such high liquidity converts into inflation,” Horn said in an interview with the German news magazine Der Spiegel.

"This doesn't just happen– the mere availability of money doesn't increase prices," he argues. "Rather, prices increase when money is spent and the current or forecasted market is so good that it allows for higher prices in the first place.”

"Inflation lacks fertile ground to grow"

In other words, if households are determined to consume and businesses invest, then prices will increase, according to Horn. If employment increases and unions are able to push through higher wages to stay ahead of price hikes, then all criteria for spiraling inflation would be fulfilled.

Still, Horn has a plausible explanation why Europe is unlikely to fall into such an inflationary cycle in the near future. “Even the most optimistic forecasts don't assume that such a constellation will occur soon,” he said.

“The level of production in Europe is still far below the pre-crisis level. There is plenty of capacity, and unemployment is high. In such a situation, companies will be unable to push through higher prices and the same applies to unions seeking higher wages. So, to put it simply, inflation lacks fertile ground to grow.”

Author: Rolf Wenkel/jrb
Editor: Sam Edmonds