A free lunch does exist in the ECB world

'There is no such thing as a free lunch' is one of those sayings that economists regularly quote. What they want to indicate is that everything you do involves costs. The sun rises for nothing.

To give a current example, immediately stopping buying Russian oil in order to reduce, if not zero, our dependence on that country would have the effect of significantly increasing our energy bills. So that would be the price. If I invite a dear friend for lunch, it still isn't a free lunch for her: she could have spent the time she spent with me differently, perhaps more productively (but of course no more fun). 

At ECB there is also free breakfast and dinner
Now you would think that this principle would certainly be known at the European Central Bank (ECB), populated with economists. However, when I read interviews and speeches from bank board members and ECB decisions, I get a strong sense that at the ECB they don't just think that there is not only a free lunch, but also a free breakfast and free dinner. !

Recently, for example, a board member of the bank clearly stated in a brilliant speech why the transition from fossil raw materials to more sustainable forms of energy will be accompanied by higher inflation. She literally referred to a 'long period of upward pressure on inflation from the energy corner'. Then the speech took on bizarre forms. During that period, monetary policy must remain loose so as not to jeopardize the transition!? An institution tasked with keeping inflation low and finding prolonged upward pressure on already high inflation should actually tighten policy. High inflation comes with high costs. You cannot allow inflation to rise in order to fund the green transition through low interest rates. There is no such thing as a free lunch. 

What does the central bank do?
But what does the ECB do? Firstly, we continue to play down high inflation to a large extent and stretch the definition of 'temporary' further and further. Secondly, talk about all kinds of proposals to create the space for themselves to be able to conduct that policy in this way. For example, by raising the target rate of inflation. Such a speech then immediately goes into its drawbacks, which is reassuring to a superficial reader, because the ECB does not seem to want to get involved. But meanwhile it is already happening! The bank expects 5% inflation this year and in 2023 and 2024 if all goes well around 2%, with a good chance of more, and hardly does anything about it. 

Another proposal that was cited in that speech and immediately (apparently) shot down is to focus on inflation without energy and food. By way of scattering monetary sand in the face, problems associated with it are immediately mentioned. But in practice this is already happening. The ECB has been talking about underlying inflation for several years and justifies its actions by pointing to it - and not to inflation including energy and food. 

While the bank has serious doubts about all kinds of academic proposals that mean that monetary policy will remain (too) loose for a long time - if not forever - those proposals are in reality everyday practice. Something that will eventually make it clear that lunch not only has a price, but that that price can also be very high.

Edin Mujagic

Edin Mujagić is an economist and manager at Beleggingsfonds Hoofbosch. He focuses on global central banks, and in his blogs he writes mainly about developments in interest rates and inflation. He has also written several books.

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