Wanted: Inflation in Germany
If all recessions have unique features, so do recoveries
The risk is the ECB will be unable to deliver a German inflation rate sufficient to offset deflation in the periphery such that the overall inflation target is achieved.
Not all recessions are the same, but they often share common features. During the post-second World War period, at least up until the global financial crisis, the causes of downturns were often either central bank actions – jacking up interest rates to stop inflation – or oil price shocks. Or sometimes both.
Our most recent recession is more of a 19th-century vintage: it was caused by a financial crisis.
One of the reasons why the US central bank, for example, was created was in response to those earlier recessions. Modern central banking has crisis prevention and firefighting in its DNA; the preoccupation with inflation is a very modern invention – something that took off, in the US and Britain at least, during the past 30 years. The specific German obsession with inflation also has clear historical roots – going back nearly a century – an obsession that was quite deliberately bequeathed to the rest of Europe with the advent of the euro.
The US and British monetary authorities have a kind of evolutionary memory of how to deal with banking crises; Europe does not. That provides at least a partial explanation for the very different recoveries experienced by the different economies. As to what happens next, the risk is that the ECB will be utterly unable to deliver a German inflation rate sufficient to offset deflation in the periphery such that the overall inflation target is achieved. That German memory again.
But if all recessions have unique features, so do recoveries. Possessing a central bank with the mandate to act in the best interests of the UK has clearly helped the British economy. But there is something about our neighbour’s recovery that is completely baffling. Or, at least, virtually unprecedented. Perhaps this is what 19th-century recoveries looked like.
Employment in the UK is booming. Everyone, from the Bank of England down, is baffled by this. On some measures, we haven’t seen employment recover this fast in recorded history. Unemployment is now back to where it was before the financial crisis. Initially, it looked like a rise in self employment, but the most recent data strongly suggests a much broader labour market recovery.
But at the same time, productivity growth is extremely disappointing. That’s another way of saying that GDP growth is incredibly employment intensive. And, as the labour market is tightening wage growth, if anything, is falling. This is not the stuff of text book economics – or of economic history.
My suspicion is that output – GDP – is being under-recorded. The UK economy is only 10 per cent physical output these days: the other 90 per cent is often intangible and tough to measure.
More broadly, rapid technological change is having two (at least) effects: it makes economies ever harder to measure and, is deflationary. The point about prices and deflation is intrinsic to the technological change process itself: the price of all forms of technology is in freefall. The application of ever cheaper, but ever better, software and hardware is playing havoc with economic measurement and is complicating the lives of central bankers.
Technological disinflationNot so long ago, globalisation was the source of disinflation worldwide. As Chinese labour starts to become more expensive, that effect will wane. But it is possible that technological disinflation could replace it. If so, the ECB won’t just have to create German inflation to offset deliberately induced deflation in Greece and elsewhere, it will also have to act on the disinflationary forces present in Germany itself. It doesn’t have the capacity, in any shape or form, to do all of this.
The current behaviour of global bond and equity markets could, as is often the case, be simply irrational. About the only way we can justify all-time highs in bond prices and stock markets is if inflation is likely to stay at current low levels forever and real economic growth also trundles along at current modest rates. That’s good enough for Britain and the US but a likely disaster in the making for Europe.