With the Unemployment Rate at an All-Time EMU Low, the ECB Prepares to Cut Rates As It Continues to Overshoot Its Inflation Target

Just the facts ma’am- Inflation has overshot the European Central Bank's target (of 2%) for 33 months in a row. Now, with the unemployment rate in the Monetary Union at 6.5%, the lowest level it's seen since the Monetary Union was formed, the ECB is preparing to cut rates. REALLY!!

Curiouser and curiouser- I cannot stress enough what a curious situation this is, especially because the ECB, unlike the Federal Reserve, has a mandate that focuses only on inflation and has no reference to growth or to full employment or the unemployment rate.

Alice in blunderland? It's as though central bankers have stepped through the looking glass and found themselves in a world quite different from the one, they used to inhabit. Once, their principal responsibility was price stability. Suddenly, they seem far more infatuated with preserving low rates of unemployment that in the past proved to be (1) elusive, (2) sustainable, and (3) even dangerous, to pursue. “I was so much older then, I’m younger than that now?” (Dylan excerpt)

A new low in unemployment or policy judgement? The unemployment rate in the monetary union has been at 6.5% in 11 of the last 12 months. This is the lowest unemployment rate the monetary union has experienced in its existence. In October 2023, there was a hiccup in which the unemployment rate moved up to 6.6% for one month and then it moved back down to 6.5% - hence 11 out of 12 months at 6.5%- hic!

A festive labor market for all…almost all The table produces statistics for 12 of the oldest EMU members. It shows unemployment rate data ranked from 1994 to date. The unemployment rates for these twelve members are below their medians for every single member except for tiny Luxembourg whose unemployment rate stands at its 78.8 percentile and has been higher only about 21% of the time. By contrast, the monetary union has never seen an unemployment rate lower than this. Belgium has seen an unemployment rate lower than its current 5.5% only 7.6% of the time. Ireland has seen its unemployment rate lower than its 4.2% only 5.5% of the time. France has seen its unemployment rate lower than its 7.4% only 8.1% of the time… and so on. Unemployment rates across the monetary union, where they are not low in absolute values, they are low relative to each country's historic experience. For example, Greece has an 11% unemployment rate; it has been lower than that only 28.5% of the time. Spain's unemployment rate at 11.5% has been lower than that only about 24.4% of the time.

Employment/Unemployment success! The point is that if we are going to evaluate the performance of the monetary union based on the unemployment rate, the ECB would be getting outstanding grades right now. Among the countries in the table only tiny Luxembourg is not experiencing what must be regarded as excellent news in the job market. Even though the European Central Bank is tasked with price stability and has been failing in this task for the past thirty months and more, it's already preparing to reduce interest rates with unemployment rates so low it would seem they have nowhere (lower) to go.

Neither the Cheese nor the ECB stands alone The exact same thing is going on in the United States where unemployment rate reached a 50-year low in the current cycle and is now just a half a percentage point above that 50-year low. For the U.S., that 50-year low is treated as the Holy Grail; yet it existed for only 9 months. These ultra-low U.S. unemployment rates were generated from 1968 to December of 1969 when the 1969-70 U.S. recession occurred. That recession was the harbinger of a decade of inflation mistakes in the U.S. It was not exactly a golden age to aspire to. Of course, 70 years ago U.S. unemployment was even lower.

The how and why of low unemployment obey the Heisenberg principle... There seems to be little recognition that the reason that countries have been able to attain these low unemployment rates has been because in the past they achieved price stability.

Having achieved low inflation and price stability, the economies have been able to perform well and deliver low unemployment. Low unemployment is the prize; it cannot be an artificial goal. To focus on low unemployment is to lose the context of what delivers it and to cause it to become elusive again. The way to low unemployment is through true price stability, not through faked low unemployment maintenance.

Experience is to be prized - only if it’s the right experience There seems to be some view among people who have experienced this period of inflation Nirvana that a period of temperate inflation is in fact normalcy. Looking back at economic history is going to tell you that simply isn't true. We have had long periods of relative price stability and we've also had periods with inflation flared. There doesn't seem to be any good reason to try to queue this period up as one where inflation is going to return to 2% all on its own like a homing pigeon.

Why a return to 2% is not inevitable Currently the global economy is experiencing a great deal of stress with the breakout of hostilities in the Middle East and outright Total War being conducted in Ukraine following an ongoing Russian attack. Warfare has put fiscal budgets under stress as western economies have been supporting Ukraine by providing armaments, but that, of course, is expensive. Budget deficits globally are generally high and national debt-to-GDP ratios are high and rising. In the wake of the global pandemic, governments and central banks provided all sorts of special stimulus that is running out of steam in some places and still carrying some momentum in others. The pandemic upset global supply chains and caused companies to change the way they were doing business; those changes haven't necessarily preserved the previous degree of competitiveness that existed in the global economy pre-Covid. With China being redlined to keep it from acquiring certain high-tech elements and struggling in other regards -the world situation has changed.

Does technology rule or are the Luddites right? While there continues to be excitement about technology and the potential for employing artificial intelligence, it's simply not clear that those elements are readily moving into the modern economy and in a way that will suppress inflation. On the other hand, it's clear that labor markets are tight, and the performance of wages continues to underline the notion that the labor market statistics are correct in flagging the labor market as tight.

The future is always opaque... There was always controversy about growth, about the adequacy of job growth, about the performance of productivity, and about the staying power that growth will have. However, there's not much question that if we run economic policy by looking in the rearview mirror, we don't see anything historically that looks anything like what we're experiencing today. History provides few examples of economies that have driven the unemployment rate down to this level and have been able to sustain it there without encountering trouble. That doesn't mean that we shouldn't try; however, it means that we should be wary of what outcome to expect if we do try to do something that has not been successful in the past. Without a really good reason to think things will be different this time, we need to realize that this objective puts us at risk.

The gravity of our situation… Every time I drop my pencil it hits my desk, it hits the floor, it falls down. I never expect to drop my pencil and to see it go up. Maybe, sometime, I'll have a chance to ride a spaceship and experience zero gravity and drop my pen and find that it doesn't fall. However, if I find myself in that circumstance, I will clearly have revised my expectations on how my pencil will react if I let go of it. Our knowledge of science, economics, social science, physical sciences, is still developing. We do know some things better than others. We know some things more precisely than we know other things. And we know few things in economics - if anything at all – in which we have the confidence that we have in gravity (genuflect). The seeming belief by some in markets that if left alone inflation is going to go back to 2% on its own is one of those things that has developed with a sense of certainty that's hard to appreciate. 2% does not have a gravitational field around it - beware.

The Wimpy-policy The Federal Reserve can fudge its policy because it has a dual mandate. The ECB has no such mandate. Meanwhile, as its headline inflation is closing in on 2%, its core inflation measures are still much farther away. I would like to be a fly on the wall at the next ECB meeting and hear exactly what it is they're saying to justify making policy easier while they continue to run failing policies as central bankers. There really must be something extraordinary at work. I don’t get it. I do think of it as “The Wimpy policy.” You remember him, right? “I’ll gladly pay you Tuesday for a hamburger today?” You see that’s the point. Stretching to maintain too low an unemployment rate today will exact its cost later…maybe not exactly on Tuesday. But the day is coming.