The countdown has begun. Even Europe, judging by the chorus of ECB members, not just the traditional "hawks", seems ready for a change: first the end of securities purchases then, already in July, a first rate increase in the wake of the Fed's moves. And the doves, for now, are silent.
"But it would be a wrong move: Europe risks a lot". To sound the alarm is Mario Noera, Professor of Economics of Financial Markets at Bocconi, attentive analyst of market problems. “I hope nothing happens. Or that we proceed to a demonstrative increase, of modest scope. Otherwise, if the risk of a recession is underestimated, we will run into the risk of a rapid reverse”. Such a pessimistic opinion is justified by the weakness on the raw materials front, not just natural gas, which limits the choices of the Old Continent's economy. “Europe has correctly focused on the energy transition. And so far it has done well. But now, in the scenario that opened with the war, we risk going backwards: let's say we want to increase the share of renewables but let's not forget that investments in gas require a lot of money. It will not be easy to find a suitable mix. I would like to speed up the energy transition as much as possible, but let's not underestimate the costs, even those that we don't talk about often".
Yet, dear professor, the hawkish voices are multiplying in favor of vigorous action against inflation which. among other things, it finds nourishment in the fall of the euro against the dollar. And Madame Lagarde seems obliged to comply. It seems obvious that in a month or so the ECB will decide to raise the cost of money. The first after eleven years. Just a quarter of a point, at first. But there is already talk of other moves within the year. What will be the consequences?
“Very serious, I'm afraid. But to justify my point of view, I would like to take a step back to highlight the different situation between the USA and Europe. There are various causes, both actual and perceived, which explain the differences between the American and European economic situation. In particular, there is a well-founded problem of excess demand in the United States. A classic case that justifies the intervention of the central bank to cool down the price trends that are moving upwards”.
In Europe instead?
“In the EU, on the contrary, the problem lies in the lack of supply, the primary consequence of the uncertainty caused by the destruction of the value chain fueled by the consequences of the war. This is the first fundamental distinction to deal with a situation that deserves different explanations and justifies different market expectations. The European economy, in particular, suffers from problems related to the shortage of raw materials, not just natural gas, which complicate the work of central bankers”.
It could be objected that the intervention on interest rates, in the face of inflation that is four times higher than the 2% target, declared Frankfurt's objective is certainly an insufficient measure in itself. But still necessary to extinguish the outbreaks. Or not?
“Frankly, I don't believe it. I think that, even according to the doctrine, the monetary treatment that is intended to be adopted is wrong. I believe that this position only reflects the uncertainty of the ECB's behaviour, starting with the ambiguity and confusion of the messages arriving from the central bank. More than giving a course to the markets, it seems to me, the line is to watch what happens and then do something".
A harsh judgment, don't you think?
“For heaven's sake, there are excellent extenuating circumstances that justify this attitude of uncertainty. The situation brought about by production bottlenecks is such that a minimal deviation may suffice to produce tensions on prices and possibly trigger inflationary spirals. I understand the concern of crushing expectations of that type right away. Let no one be under any illusions, because the central bank is ready to shut down demands for wage increases. A small increase can serve to ease tensions. But there is a but”.
Or?
“If, as is the case today, wage tensions are only theoretical, the central bank's warning risks having severely recessive effects. Maybe not immediate. But also of rapid effect in a situation like the current one, which is deteriorating very quickly. Let's not forget that we've already eaten all of this year's growth, barring the deadweight effects of past progress. But now we have to look at what will happen next year, with the unknown factor of the ongoing war and the cascading effects on the various economies. My impression is that we are more at risk of a recession than an inflationary spiral. And it scares me that, faced with a danger of this kind, Europe is discussing the reinstatement of the stability pact. So we'll go crashing like it happened other times ".
Like in 2011 when the ECB raised rates, triggering the powder keg of the Greek crisis?
“It fits the precedent of the XNUMXs oil crisis better. The decision of the large producers to raise prices exponentially triggered a supply shock setting the stage for the subsequent stagflation. In such a framework, the task of central bankers becomes almost impossible. Businesses, in fact, initially suffer the blow of the drop in profits but do not raise their price lists, so as not to lose customers. This sets in motion a self-correcting effect on demand”.
Raising rates is likely to be useless. Is that so?
“It is difficult to calibrate monetary intervention in the face of such an uncertain diagnosis: You don't know if expectations or recessive pressures will prevail. Some think that this time the blow of the war, if there is no positive outcome in a short time, will be so recessive that we will soon find ourselves grappling with the opposite problem, that is deflation”.
To go back to the XNUMXs, even tensions on wages can explode almost by surprise…
“I don't have a crystal ball but I don't see the premises for such an evolution. For several reasons: a fragmented labor market, the use and abuse of outsourcing, weak wage dynamics almost everywhere: wage dynamics, which are the real accelerator of inflationary expectations, are not yet seen in Europe. On the contrary, the US is experiencing a situation of full employment”.
What should the ECB do?
“Tighten a little but not too much, send signals but the bulk of the work must be done by others: industrial policy, subsidies to reduce emergencies. And fiscal policy above all. Unfortunately, this time the task is really complex because we are facing the node of raw materials. Today we are talking about gas, but the shortcomings in other fields are no less serious. Chips are strangling the auto industry. What are the incentives for if there are no products? The task of the central bank, in such a framework, must be to encourage virtuous processes, stimulating an expansive fiscal policy. But this requires resources that Europe is not mobilizing for now”.
Are you not convinced by the European energy plan?
“It's a compromise solution. In reality, the Union, starting with Germany, is struggling to find a new position after the end of Angela Merkel's policy, based on compromise with Moscow. Today, having skipped that pattern, we don't have a replacement ready. Perhaps, speaking as a geopolitical cynic and not as a Putinian, a little more prudence was needed. Now, returning to the central banks, the ECB's room for maneuver is limited by the dead end into which Europe has slipped itself”.
Solutions?
“Or we bet everything on renewables with many massive investments to compensate for what we lose. My working hypothesis is to accelerate the transition with massive incentives. But there is also the other side of the coin: this policy has a cost, which is not only that of investments but also that of the assets that you are going to dispose of and that are worth a lot: pipelines, refineries and so on. No one ever calculates the amount of stranded assets that risk falling to zero in the short term from the balance sheets of giants such as Eni, called upon to replace core assets in record time for this reason”.
In this scenario, the ECB seems to have its hands tied. Or not?
“I believe that in this situation monetary policies will hardly become restrictive. If, on the contrary, they become so, we risk a great deal. Monetary policy today can moderate expectations but not solve the inflation issue. To prevent price increases, it is necessary to address production bottlenecks. And there the central bank alone can do very little”.
Prof. Mario Noera is absolutely right.
The ECB is making a serious mistake that will undermine the economic and social stability of the Euro area.
Even in the past the ECB had taken the path of increasing interest rates, producing a strong negative impact on the economies of many Euro countries, fortunately Mario Draghi intervened with "quantitative easing", otherwise today we would not have a Europe.