Cheap Money Comes at a Steep Price

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The ECB should hold firm to its mandate to ensure price stability and pursue a serious contractionary monetary policy.

During the Great Depression in the United States children did not have many toys for amusement. One form of entertainment involved kicking a can in the streets and chasing each other around. The game was simple and futile, but at least it was fun. It distracted the children from the dreary and unpredictable reality faced by their parents.

Today we have access to toys and devices aplenty. But our reality feels no less uncertain. We seem to be in an age of inflation – rising costs are certainly top of mind for the average consumer who struggles to afford basic necessities. This makes it even more unfortunate that the usual confusion prevails concerning the true causes of inflation. If we do not understand the true causes, then we will be unable to figure out effective solutions. Instead, kicking the proverbial can down the road, we will continue to treat symptoms, only to be surprised when they reappear in worse form down the line.

Let us begin by dispelling one of the most commonly adduced reasons for our present inflation – namely, Russia’s invasion of Ukraine. The war has been tragic on many levels – not least the human one – but even prior to the invasion consumer price inflation stood at 6% in the Eurozone, and producer price inflation hit nearly 24%. The war has provided a convenient pretext for inflation, concealing the various policy missteps that brought us to this point in the first place.

Before the war broke out the world was trying to return to normal by breaking out of government-imposed lockdowns. Lockdowns brought many sectors of the economy practically to a screeching halt, eliminating businesses (or encouraging government largesse to rescue businesses) and fracturing global supply chains. The post-lockdown demand rebound combined with diminished supply could only exert tremendous upward pressure on prices. This is not the place to debate the wisdom of government policy in regards to COVID-19. It need only be observed, however, that the decision to lockdown was far from inescapable. Maligned during the early stages of the pandemic, Sweden proved that leadership in the interest of freedom is still a viable option. If more countries had adopted the Swedish solution, then the inflationary effects of the post-lockdown rebound would have been mitigated.

But mitigated only to an extent. In truth, the groundwork for our present inflation woes had already been painstakingly laid over several years. The ECB’s monetary policy since 2009 has kept interest rates negative. Further cheap money has flooded the economy more recently to the tune of some 5 trillion EUR in the form of the Asset Purchase Programme and the Pandemic Emergency Purchase Programme. Any stimulating effect of these monetary injections will have been severely blunted by the lockdowns anyway. If uncertainty among consumers and investors diminishes, there will be an increase in the velocity of money which will put additional upward pressure on inflation. At that point the key question will be whether central banks can pull money out of the economy – a question that many central banks are already reluctantly facing.

What complicates matters for central banks are the staggering levels of public debt across the continent. For example, in Austria, 20 years ago, when the euro was introduced, debt stood at 150 billion EUR, with interest payments at 8 billion EUR. Now debt is at 335 billion EUR, with interest payments at 4.5 billion EUR. The debt will be magnified considerably when these artificially low interest rates rise, thereby impairing various public services and entitlements to which Austrians have become quite accustomed. It’s the same story across Europe.

Now, the ECB’s mandate is to ensure price stability. But it will be strongly pressured by Eurozone governments to soften the effects of an economic downturn and thus keep interest rates as low as possible. And this pressure will be compounded if inflation expectations increase and unions demand higher pay to avoid a wage-price spiral. In response to all of this the ECB should hold firm to its mandate and pursue a serious contractionary monetary policy, notwithstanding calls for smaller rate hikes. This will prove its willingness to rein in both inflation as well as inflation expectations.

More fundamentally, economic prudence must not be subordinated to the vagaries of politics. The ECB walks another fine line in attempting simultaneously to fulfil its mandate as well as bolster the green transition. As desirable as it is to arrive at an economy fueled entirely by renewable energy, we must be honest about the trade-offs and the time it will take. For example, extracting the energy transition minerals essential to electric car batteries, solar panels, wind panels, and much else besides, causes pollution. Furthermore, the steel required in these cases is still largely produced in coal-fired blast furnaces. If countries actually take seriously the commitments made in the Paris Agreement, it is estimated that demand for energy transition minerals could rise by more than 450% by the year 2050.

There is a lag, moreover, of on average 16 years between mine discovery and production. The Austrian economists lay great emphasis on the time factor in the production process and everything that can happen in the meantime. Hence our warnings against government and central bank distortions of the economy – individuals face enough uncertainty as it is. We need only reflect on the fact that a mere 16 years ago we were preparing to enter the financial crisis. Today already feels like a much different world.

Misguided green policies, disrupted supply chains, excessively cheap money – all have played their part in bringing about inflation. The remedy will not be painless, but a course correction is possible only if we lower public debt by limiting public expenditures, pursue a contractionary monetary policy, and ultimately leave individuals the room they need to innovate and create their own prosperity. Increasing debt levels in the pursuit of climate targets will only make the problem worse. If the past years have proven anything, it is that there are definite limits to the ability of governments and central banks to eliminate uncertainty and secure individual wellbeing. In fact, in an unfortunate demonstration of the pretence of knowledge, their loose fiscal and monetary policy has undermined the very certainty and wellbeing it was meant to promote. Fortunately, Europe is a continent of 450 million individuals, each of them full of ideas and willing to realize them, provided they are free to do so.

But if governments and central banks instead decide to continue kicking the can down the road, then people may not have the chance for much else other than the same futile activity. Just like the kids in the Great Depression.


  • Barbara Kolm

    Barbara Kolm is President of the Hayek Institut, Founding Director of the Austrian Economics Center and former Vice-president of the Austrian National Bank.

The views expressed on austriancenter.com are not necessarily those of the Austrian Economics Center.

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