Eurozone consumer prices increased by 5 per cent year on year in December 2021, while the number of Google searches for “inflation” has recently risen three-fold in Germany and ten-fold in France.
So, at first glance, it is difficult to avoid the impression that Europe — like the United States, where annual price growth has hit 7 per cent — will have a tough time taming the inflation dragon.
Both the Fed and the ECB can certainly be blamed for not having spotted the current price surge early enough. But that is no reason to lump together the US and the eurozone.
Contrary to the widespread belief that inflation is back for good on both sides of the Atlantic, the outlook for the US is fundamentally worse, for three reasons.
First, under former president Donald Trump and his successor, Joe Biden, the US tackled the fallout from the Covid-19 shock with a massive fiscal stimulus.
From March 2020 to September 2021, money transferred to households and businesses in the US through exceptional tax cuts, top-ups to unemployment benefits, debt forgiveness, and other schemes amounted to a whopping $2.5 trillion, or more than 11 per cent of pre-crisis GDP.
True, part of this money substituted for the lack of strong, built-in shock absorbers of the sort that have long been common in Europe. Extra unemployment benefits, for example, were made necessary by the limited generosity and short duration of the standard payments.
Europe, meanwhile, was paradoxically more generous and thriftier at the same time. When French President Emmanuel Macron announced in March 2020 the launch of a massive furlough scheme whereby the government would pick up the wage bill of employees idled by the pandemic, he said loud and clear that the state would fulfil its responsibility to protect, “whatever the cost.”
Not everyone in Europe said the same, but virtually all governments adopted the same position. For a while, there was no budget constraint anymore, and the ECB stood by to help governments do their job.
The second factor is that furloughed workers in Europe retained their labour contracts and the associated employment security. True, temporary workers and those on fixed-term contracts paid a high price as a result of the Covid-19 crisis, and new entrants into the labour force also struggled.
But, on the whole, European states acted like insurers and protected workers and employers from a devastating shock.
So, it should be no surprise that Europe’s pre-pandemic labour force remained largely intact once the worst was over.
US policymakers, in contrast, are still wondering what caused 2.7 million workers to disappear during the crisis, and how to avert multiple bottlenecks in an economy where a demand overhang coexists with supply constraints.
The final reason why inflation threats are more worrying in the US is that the Fed had explicitly committed itself to keeping its powder dry.
Back in August 2020, Fed Chair Jerome Powell unveiled a new strategy whereby policymakers would aim to achieve prolonged above-target inflation after a period of below-target inflation, and would also seek to promote “maximum employment.”
The quid pro quo for such a bold rethink should have been a responsible fiscal policy. But now that Congress and the president have made the opposite choice, the Fed finds itself forced to change course precipitously.
To be sure, the ECB also faces constraints. Everybody wonders whether Italy, with public debt that has jumped to 155 per cent of GDP, will be able to place bonds with investors once the ECB starts unwinding its bond-purchase program. But at least the ECB hasn’t added a constraint of its own.
©Project Syndicate, 2022
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