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by Robert Brusca May 18, 2016
EMU headline prices fell by 0.2% year-on-year. Core inflation registered a gain below 1% at 0.8%, and the trends for inflation are largely lower. Has the monetary game changed or is it the same-old same-old game that the ECB has continued to play? If it's the same game, do these results mean that ECB tactics are not working? If they don't work, what will?
Inflation trends are lower
Inflation in the EMU is falling year-on-year despite repeated efforts by the ECB. The price level is dropping and sequential calculations show that momentum is the downward direction has been gathering pace. There is hope, of course, that with the energy price reversal on global markets, these trends will turn. HICP inflation on a core basis puts EMU wide prices up by 0.8% year-on year, but they also reveal withering trend with the core pace falling to 0.5% over six months and falling further to 0.2% over three months. Arguably that too is the effect of weak oil/commodity prices in the pipeline. But at the same time, Europe's economic data continue to show a great deal of sluggishness.
The oil-slicked calf
There is no economic revival on which to base the hope or conclusion on for higher prices. For now that is all laid at the feet of oil and commodity prices, a suspiciously fickle altar at which to worship.
All in the same boat
The table above shows HICP trends for total inflation as well as observations for core HICP behavior. What is clear is that the trends are shared across the EMU and that for the EMU largest members along with the U.K., core and headline inflation are slipping and negative in the most recent period although with a few notable exceptions like Germany and France over three months and core French inflation over three months. But the exceptions are not the real story here; the story is about the uniformity of the pressures faced by EMU members and the U.K. and the policy responses.
For EMU members, being boiled in the same currency cauldron give them the same flavor. The U.K. has currency independence, but it is tied to Europe though trade and lives in the same global environment with the same `greenhouse' effects.
Independence in an era of dependence has consequences
The EMU has long been a disciplining arrangement for most EMU members, but most had not realized it until the financial crisis hit. Up until that time, independent and quite inconsistent policies were pursued and debt and deficit rules were often ignored giving rise to persistent inflation differences inside the EMU community. These vastly differing price levels that evolved put competitiveness on very uneven footing inside the community. In the end, the countries that had allowed this fiscal situation to stray the most have suffered the most price level damage and have been forced to adjust in some cases using harsh austerity medicine.
EMU inflation is a construct not a reality
The table below shows the record of the earliest EMU members in containing inflation during the period since the EMU was formed. Some members had come a long way at the time of the euro's creation and had reduced inflation to a more moderate pace by the time the euro was launched. But moderation was not good enough. Germany became the anchor country for inflation and for economic data since it has the largest economy and its performance would get the greatest weight. There is in reality no single `EMU' inflation rate, but the one that was reported was dominated by Germany.
One ring to rule them all...
One peculiar outcome from this was that many EMU nations would overshoot a 2% inflation target, but if German ran a low enough rate, the EMU region's rate (the EMU-wide metric) might still hit target. Through this process, Germany gained hugely in competitiveness as most of the rest of the EMU lost ground to it.
And in the darkness bind them?
The table show shows how this worked as Germany ran an inflation rate and engineered a net price level rise less than any other EMU member -driving down the weighted EMU average (or overall HICP). Germany's price level rise since the EMU formation is 6.1 percentage point less than for the EMU as a region and the EMU gauge has Germany's performance embedded in it with a large weight. We see the scope of the differences more by looking at the price level differences of various members with Germany (far right hand column). There we show the maximum divergence countries have had vs. Germany since the EMU was formed. Greece and Ireland had price levels that had risen at their worst to over 30% higher than the price level in Germany compared to the starting point at the EMU formation. Luxembourg, Portugal and Spain had price level divergences that were greater than 20% higher that Germany's. Italy maxed out at 15.6%; Belgium at 12.4%; the Netherlands at 14.3% and so on. Only France held on like, well, a French bulldog. Only France among this group kept its CPI from rising as fast or faster than for the EMU as a whole. The French knew what game was being played and hung on for dear life. Despite still having huge competiveness problems because of work rules, France has managed to contain its price level better than most. And those with the greatest divergences subsequently were bought under the greatest restraints.
Austerity works but without an anesthetic
The second column from the right reflects the CPI price level divergence in current terms. Here you can see that Greece's austerity pain has produced remarkable results in terms of realigning its price level with other members of the community. This is why some refer to austerity as an `internal devaluation'. It brings the price level down while Greece remains inside the common currency area. There is no exchange rate effect but Greek relative prices are adjusted. And we know that adjusting nominal prices is painful. Ireland also underwent austerity and has also made great strides and suffered great pain. Spain and Portugal have made significant progress under their restrictions but still have a long way to go. Germany remains clearly the most competitive country in the EMU based on CPI price levels in the EMU.
Clash of the Titans and Lilliputians- No meeting of the minds
And yet many of the same old fights are being fought, Jens Weidmann today noted that the way monetary policy is being run is blurring the lines between fiscal and monetary policy. He is right. But Germans who are quick to make such blanket statements stand mute on the ECB's poor record of hitting its inflation target (and ignore the high rates of unemployment elsewhere in the EMU). Other EMU members with much higher rates of unemployment are more eager to get inflation up and to put growth on a better track. Germany is happy with inflation nearly at or below 2% and its unemployment rate at a reunification low! You will not catch any German critical of the ECB's inflation undershoot or saying that boosting inflation is a high priority. Germans may grudgingly say that low inflation (however, most Germans still call it `moderate' inflation) can justify some of what the ECB is doing. But Germany clearly does not want the ECB's feet held to the fire except when inflation overshoots.
Germany understands the game and its rules
By pursing its low inflation strategy, Germany has managed to make itself the low price level country in the EMU and therefore it benefits the most in trade inside and outside the region.
France walks a tightrope
France continues to have pains from its ongoing battle to maintain a French lifestyle with a German price level. Right now unions are striking in France to try to resist some new work rules that are being implemented.
Lots of dilemmas and discord
There are similarly ongoing local issues ranging from Greece's now wanting more debt reduction (supported by the IMF). Spain has seen the rise of the powerful Podemos party that wants to end austerity. Italy is a bigger mess than its inflation performance would let on.
Same old fights no Vulcan mind melds
At the end of the day, Europe continues to fight all the same battles it has fought since its formation. There is little sense of policy consensus, convergence, empathy or learning. The Germans don't learn; they KNOW. Just as the Germans forced many into a post financial crisis straight jacket called austerity, now those same members want to rub the German's noses in an ECB policy that they abhor while inflation is undershooting and the ECB is vulnerable to manipulation. Yet, this tit-for-tat, back and forth, has not produced much in the way of results. Should Europe try to carve out a new policy approach? If so, what would it be? Would the Germans allow more fiscal tolerance for a few years if the ECB were restored to a less adventurous role? Is that compromise attainable? Could it help to lift Europe out of the soup?
Euro-soup meets Miso soup
Today from Japan we hear Prime Minister Abe talking about the need for the G7 to boost global demand. There is a G7 meeting in Japan on tap for next week. But there is no sense that anyone has put fiscal policy on the table. Abe is speaking of `creating demand and removing supply-side constraints' which sounds like jargon rather than a workable plan. But maybe the G7 will surprise us and DO something. But don't hold your breath unless you want to be member of blue man group.