This morning’s decision by the ECB to leave its monetary policy unchanged was highly disappointing since it clearly suggests that economic considerations were not foremost in the ECB’s decision making process. Rather, it suggests that the ECB was bowing to the will of Germany, its major shareholder, which has made no secret of its opposition to a more proactive ECB. This does not bode well for an early change in the ECB’s policy stance ahead of the May 2014 European parliamentary elections, which has to heighten the risk that the eurozone will in the end succumb to Japanese-style deflation.
By almost any economic metric, by now the ECB should have been adopting a very much more aggressive monetary policy stance than it is presently doing in order to ward off the risk of deflation. Inflation at 0.7% is running at around a third of the ECB’s “below but close to 2 percent” inflation target; overall eurozone unemployment remains stuck at a record high of 12%; the economy is recovering at an anemic pace from its longest post-war economic recession; and the strength of the euro adds to disinflationary pressure.
Further arguing in favor of a more aggressive ECB policy stance is the ECB staff’s own lackluster economic forecast. This forecast suggests only a modest eurozone economic recovery over the next two years that will not be strong enough to reduce unemployment to below 11.8% by 2015. In addition, according to the ECB staff, overall European inflation will only increase to 1.3% by 2015, which would leave inflation well below the ECB’s inflation target.
The fact that the ECB has not moved to a more aggressive policy stance, despite the overwhelming economic justification for doing so, has to suggest that the ECB is bowing to political pressure. The most obvious source of that pressure has to be Germany, its major shareholder. Unlike much of the rest of the eurozone, the German economy is doing rather well, its unemployment rate is low, and its inflation rate is running not far from the ECB’s target. All of these factors make German policymakers fearful of the inflationary impact for Germany of an easier ECB monetary policy stance.
Sadly for Europe, the German political calendar is such that it does not lend itself to the ECB disregarding German political resistance to a more accommodative policy stance anytime soon. The German constitutional court is set to rule on the constitutionality of the ECB’s Outright Monetary Transactions program in April, while European parliamentary elections are scheduled for May. This would suggest that the economic data would have to deteriorate a lot for the ECB to move to a more aggressive policy stance before May. It would also suggest that by the time that the ECB does move, it will all too likely be too late for the ECB to avert Europe’s present deflation risk from being realized.