With the war in Ukraine, the European Central Bank is at a loss what to do. An acceleration of the tightening of the monetary policy, which it insisted on doing until a few weeks ago, would enlarge the panic on the already frightened financial markets. Doing nothing however, is not an option either, since inflation is rising and rising. Casper de Vries, Professor of Monetary Economics at Erasmus School of Economics, discusses these issues in an interview with the Telegraaf (9 March 2022).
Recession
De Vries is determined that the eurozone will face a recession. The war in Ukraine causes a lot of unrest and higher energy prices. This affects Europe more than North America, since Europe imports more energy than North American countries.
Stagflation
Before the war, economists feared for a wage-price spiral and an overheated economy. Now however, it is feared that we will experience stagflation: a stagnating economy with rising inflation. The Professor argues that only the government is able to tackle stagflation and not the Central Bank. The government should make use of their budgetary policy. For instance, if the government wants to compensate the most affected groups in society, it should raise the tax burden on the least affected group, and compensate the most affected groups with the additional tax revenues.
The European Central Bank
This pending stagflation does not mean that the European Central Bank should accelerate the termination of their asset purchase programmes. De Vries argues that a quicker termination of these programmes will cause a rise in interest rates for countries in the eurozone, which is bad for the economy. The reason for this, is that countries in the eurozone have large government debts, especially in the southern countries. Furthermore, termination of those programmes will create even more panic in the already nervous financial markets.
Buying more government bonds is also unwise. The interest rate is already at a historically low level of -0,5%. Thus, an increase in spending on government bonds will deteriorate the exchange rate of the euro even further. Which will make energy even more expensive for the eurozone.
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For the whole article by the Telegraaf, 9 March 2022, click here.