Emergency meeting at ECB, long high inflation threatens

Big news from the ECB country. No, I'm not talking about the bank about to raise interest rates for the first time in 11 years, as was decided last week in Amsterdam. That was allowed, with the screeching inflation while it is your job to keep it low. No, I'm talking about the promise that the bank will not sit back if the interest rate differentials between the weak and strong euro countries, think Italy versus Germany, become too large.

This so-called spread is a thorn in the side of the bank. Why? Because according to the ECB it 'disrupts the functioning of the monetary transmission mechanism'. The monetary transmission mechanism is the term for the channels and processes through which an interest rate change by the ECB affects the economy. This includes its influence on savings rates, mortgage rates, corporate interest rates, the euro exchange rate, rates on the financial markets, wages and expectations about all these matters and the ultimate influence of all this on inflation. Worrying about its operation means something like worrying about 'if we do something in Frankfurt, it won't work equally well everywhere in the currency union.'

The promise of Mario Draghi
And so the bank promised to do everything it could to club those spreads down if they get too high. 'Everything' is then not only every instrument that the bank now has, but also means that it can devise new ones. 'Everything' is in fact an underlining that 'whatever it takes' continues to apply. 'Whatever it takes' was the promise of then ECB president Mario Draghi that the bank will do everything to save the euro. Over the past few days, long-term interest rates have risen considerably, as have spreads. Yesterday, members of the ECB Governing Council were invited to an emergency meeting on it on Wednesday morning. It's the world upside down.

These spreads are increasing because one euro country has very high debts and the other does not. One euro country has allowed debts to rise further since 2012, the other less so. That in turn cannot be separated from the 'whatever it takes' promise. If the ECB makes such a promise, you are encouraging countries like Italy to really ignore European fiscal rules, however flexible and non-binding they may be.

Open invitation to ramp up debt
That spreads are now widening is the price of Draghi's 'whatever it takes', the open invitation to ramp up debt further and not reform finances. If that threatens to go wrong, in the sense of taking on too much debt, the ECB will always step in. Because the future of the euro could be at stake.

By the way: the bank has it very high on its mind. The ECB says it will intervene in spreads when they are 'fundamentally wrong'. As if the ECB, or anyone for that matter, can know when the spreads are fundamentally wrong. What the ECB should do is encourage euro countries with over-indebtedness to reduce it and, together with the European Commission, make a case for this. And certainly not rewarding such irresponsible behavior and encouraging it to continue. The price of the ECB wanting to steer the spreads, or the price of today's emergency meeting of the bank, will, I fear, be structurally high inflation in the coming years.

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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