{"id":29563,"title":"Inflation, Unemployment and Public Debt &#8211; the Dilemma Facing the European Central Bank","link":"https:\/\/bst-europe.eu\/de\/investment-budget\/inflation-unemployment-and-public-debt-the-dilemma-facing-the-european-central-bank\/","date":"21. Februar 2022","date_unix":1645443483,"date_modified_unix":1754482631,"date_iso":"2022-02-21T11:38:03+00:00","content":"<p><em>In <\/em><a href=\"https:\/\/bst-europe.eu\/globalization\/the-u-s-is-on-the-verge-of-an-interest-rate-180-but-the-euro-area-not-yet\/\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\"><em>a previous post<\/em><\/a><em>, we discussed the US Federal Reserve\u2019s almost certain decision to raise key interest rates and the reason why we think this strategy is not one the ECB will pursue &#8211; at least not yet. Here\u2019s why:<\/em><\/p>\n<h2><strong>The Economies in the Euro Area are Wildly Diverse<\/strong><\/h2>\n<p>In the euro area, a key interest rate increase is currently less likely than in the U.S., not only because of the lower economic dynamics on average of all euro area member states but because the euro area economy is also much more heterogeneous.<\/p>\n<p>Looking at selected macroeconomic data in four southern European and three western European member states, it is clear that the decision to raise rates in the euro area is more nuanced.<\/p>\n<ul>\n<li>The <strong>economic slump<\/strong> in 2020 was noticeably larger in the four southern European economies of Greece, Italy, Portugal, and Spain than in Germany, Austria, and the Netherlands. Growth in 2021 and 2022 will not be sufficient in the southern European states to compensate for this disadvantage.<\/li>\n<li><strong>Unemployment<\/strong> is also noticeably higher in the four southern European countries than in the other three.<\/li>\n<li>Weaker economic development means that the growth of aggregate demand is smaller. Thus <strong>inflationary pressure<\/strong> is lower in Southern Europe, at least in Portugal and Italy.<\/li>\n<li><strong>Government debt<\/strong> in the four southern European countries is significantly higher than in the three western states.<\/li>\n<\/ul>\n<figure id=\"attachment_29567\" aria-describedby=\"caption-attachment-29567\" class=\"wp-caption alignnone\"><a href=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/ONE.png\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\"><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-29567 size-large\" src=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/ONE-1024x572.png\" alt=\"Graph: Macroeconomic key indicators of selected euro area countries\" width=\"1024\" height=\"572\" srcset=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/ONE-1024x572.png 1024w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/ONE-300x168.png 300w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/ONE-768x429.png 768w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/ONE.png 1492w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/a><figcaption id=\"caption-attachment-29567\" class=\"wp-caption-text\">Explanations and sources: Monthly inflation, defined as percentage change on the same period of the previous year as a percent: OECD.Stat (download data on 8.2.2022), the year-over-year change in real GDP in percent (data for 2021 and 2022: estimates) and government debt (Debt), defined as government debt-to-GDP ratio in percent (estimate): IMF World Economic Outlook Database, October 2021 (down-load data on 15.1.2022), unemployment rate (Unempl.) in percent: Eurostat (download data on 8.2.2022).<\/figcaption><\/figure>\n<h2><strong>An Interest Rate Hike Now Would Come Too Early For Those Countries with Weak Economic Development<\/strong><\/h2>\n<p>The <strong>need<\/strong> for an interest rate hike and its <strong>impact<\/strong> are very different for different countries in the EU.<\/p>\n<p>In southern European economies, <strong>inflationary pressure<\/strong> is currently not as great as in the faster-growing western European economies. With unemployment higher in the southern economies, the risk of a wage-price spiral is relatively low.<\/p>\n<p>In addition, lower economic growth means southern European economies are less able to cope with a rise in interest rates and its <strong>growth-dampening<\/strong> effects.<\/p>\n<p><a href=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO-.png\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\"><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-29569 size-large\" title=\"Graph: Rising interest rate causes lower employment and lower GDP\" src=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO--1024x572.png\" alt=\"Graph: Rising interest rate causes lower employment and lower GDP\" width=\"1024\" height=\"572\" srcset=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO--1024x572.png 1024w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO--300x167.png 300w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO--768x429.png 768w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO--1536x857.png 1536w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/TWO-.png 1838w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/a><\/p>\n<p>Particularly serious is the significantly higher <strong>government debt ratios<\/strong> in Southern Europe. For them, a rise in interest rates means increased interest expenditures. A higher interest rate reinforces the increase in government debt. This worsens the long-term sustainability of public finances in the southern European states. Hence, a rise in <strong>risk premiums<\/strong> threatens to exacerbate the debt problem.<\/p>\n<p><a href=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE.png\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\"><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-29571 size-large\" title=\"Graph: Rising interest rate causes lower employment and lower GDP\" src=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE-1024x578.png\" alt=\"graph: interest rates\" width=\"1024\" height=\"578\" srcset=\"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE-1024x578.png 1024w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE-300x169.png 300w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE-768x433.png 768w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE-1536x867.png 1536w, https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2022\/02\/THREE.png 1840w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/a><\/p>\n<h2><strong>The ECB has \u00a0a Dilemma<\/strong><\/h2>\n<p>If the ECB includes the effects of a key interest rate increase on the long-term sustainability of public finances in its decision-making, it must \u00a0consider the government debt of all 19 states.<\/p>\n<p>If one of these states loses its credit rating, there is a threat of <strong>state bankruptcy<\/strong>, which could cause domino effects in the real economy like after the <a href=\"https:\/\/bst-europe.eu\/globalization\/10-years-after-lehman-does-another-economic-crisis-loom\/\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\">Lehman bankruptcy<\/a>. At the same time, the bankruptcy of one euro area state could lead to fears that other euro area countries could also become insolvent.<\/p>\n<p>So while the Fed can base its monetary policy on the average development of all U.S. states, the ECB must orient itself on the weaker euro area countries. Only if economic growth is strong enough in all 19 countries can an increase in the key interest rate occur can the ECB raise rates. However, by then, inflation rates in fast growing countries of the euro area may already be too high. This is a <strong>conflict of goals<\/strong> which can be difficult to resolve.<\/p>\n<h2><strong>Economic Policy Options for the Euro Area<\/strong><\/h2>\n<p>Even though the ECB is not expected to raise key interest rates until the end of 2022 to stabilize growth and government debt \u00a0(though likely, at the earliest in Q3 and only by a small amount) &#8211; those responsible for monetary and fiscal policy as well as all other market participants should prepare for a period of higher interest rates in the euro area.<\/p>\n<p>However, the transition to a phase with higher interest rates must be accompanied by economic policy. The measures currently being discussed &#8211; include the following:<\/p>\n<ul>\n<li>The ECB should <strong>communicate<\/strong> as clearly as possible the timetable of the envisaged monetary policy measures so that all market players can prepare for higher interest rates.<\/li>\n<li><strong>Government spending<\/strong> should be used to strengthen economic growth in order to increase future government revenues.<\/li>\n<li>Governments should <strong>restructure<\/strong> their <strong>debt<\/strong> by replacing short-term loans with long-term loans securing low interest rates for the longer term.<\/li>\n<li>Economic policy needs close <strong>coordination<\/strong> between monetary and <a href=\"https:\/\/www.ecb.europa.eu\/press\/key\/date\/2021\/html\/ecb.sp210628~695f98b30c.en.html\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\">fiscal<\/a> policy so that government spending can compensate for the decline in demand in the economy resulting from falling investment.<\/li>\n<li>Temporary <strong><a href=\"https:\/\/voxeu.org\/article\/corona-bonds-great-idea-complicated-reality\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\"  target=\"_blank\" rel=\"noopener\">Corona<\/a> Eurobonds<\/strong> are another instrument under discussion. This would make the entire <a href=\"https:\/\/bst-europe.eu\/europes-future\/a-weak-euro-what-does-it-mean-for-europes-economy\/\" target=\"_blank\" aria-label=\"\u00d6ffnet in einem neuen Tab\" >euro<\/a> area liable for individual countries&#8216; debts and thus prevent the rise in risk premiums for countries that are currently particularly highly indebted.<\/li>\n<li>In the long term, the euro area should try to establish the <strong>euro<\/strong> as a <strong>global reserve currency<\/strong> alongside the U.S. dollar to benefit from low risk premiums.<\/li>\n<\/ul>\n<h2><strong>The Optimal Set of Political Measures -has Yet \u00a0to be Found<\/strong><\/h2>\n<p>Which measures under discussion constitute an optimal bundle of measures can only be determined after weighing all the advantages and disadvantages as well as the interactions and side effects. (Such an analysis is beyond the scope of this article.)<\/p>\n<p>Nevertheless, at least one recommendation can be made: When looking for a suitable package of monetary and fiscal policy measures, <strong>several macroeconomic target<\/strong> variables should be kept in mind: inflation rate, employment, GDP level, as well as government debt.<\/p>\n<p>To avoid social tensions, distributional effects of the economic policy instruments must also be taken into account.<\/p>\n","excerpt":"<p>In a previous post, we discussed the US Federal Reserve\u2019s almost certain decision to raise key interest rates and the [&hellip;]<\/p>\n","thumbnail":"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2021\/12\/imelda-GcnPjvqRL18-unsplash.jpg","thumbnailsquare":"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2021\/12\/imelda-GcnPjvqRL18-unsplash.jpg","authors":[{"id":312,"name":"Thie\u00df Petersen","link":"https:\/\/bst-europe.eu\/blogger\/dr-thiess-petersen\/"}],"categories":[{"id":598,"name":"Investment &amp; Budget","link":"https:\/\/bst-europe.eu\/category\/investment-budget\/"}],"tags":[{"id":202,"name":"eu","link":"https:\/\/bst-europe.eu\/tag\/eu\/"},{"id":379,"name":"European Central Bank","link":"https:\/\/bst-europe.eu\/tag\/european-central-bank\/"},{"id":340,"name":"Inflation","link":"https:\/\/bst-europe.eu\/tag\/inflation\/"}]}