Inflation in the Netherlands continues to climb

13,6%. Inflation in the Netherlands was this high in August, the Central Bureau of Statistics (CBS) reported this morning. It is now so long ago that prices rose so fast in the Netherlands, that it may just be that the undersigned is the only Dutch economist who has experienced such high inflation. 

The board of the European Central Bank (ECB) will meet next week. In the eurozone, the currency depreciation is 8,9%. There is a good chance that this will increase in the coming months. The board is going to talk about how much to raise interest rates to curb inflation. And many (self-proclaimed) economic experts find this objectionable. There are two arguments for why the ECB should not raise interest rates. The first argument is that the eurozone economy is heading for a recession. Then you should not rub salt in the wounds, according to the monetary community. The second argument is that inflation is mainly caused by high gas and electricity prices and that interest rate hikes by the ECB cannot do anything about it. Both arguments sound very plausible. Nevertheless, both are pure nonsense. 

Not fulfilled the task for a year
Take the first argument. The ECB would not have been in such a situation if the bank had previously raised interest rates instead of keeping them at -0,5% as the economy grew. Second, the ECB's job is NOT to save the economy from recession, fight climate change, or whatever. The bank's sole task is to ensure price stability. The bank defines this with an inflation rate of 2% per year. The ECB does not comply. Not only not now, but since 1999 the bank has actually not complied for one year.

With regard to the second argument. Central bankers have a measure of inflation called core inflation. That is inflation without volatile energy and food prices. That inflation rate is also well above the ECB's target rate. In other words: inflation is not only caused by high gas and electricity prices, but also for another reason. That is, in my view, the ECB keeping interest rates too low for too long.  

Avoid economic pain
Besides, every monetary economist knows that a central bank can never do anything about inflation here and now. It takes a while before interest rate changes have an effect on currency depreciation. It usually takes about one and a half to two years. So when a central bank raises interest rates to tackle inflation, it looks two years ahead. In 2022, this means that the ECB has its sights set on 2024. And with regard to 2024, inflation is more likely to be higher than lower than 2% sooner. If the ECB does nothing or too little now, the bank runs the risk that this temporary high inflation will become permanent, via higher inflation expectations and faster wage increases. As for the economic pain of rate hikes now, if the ECB waits, then the rate at which it needs to raise rates going forward - to drive that permanently higher inflation out of the economy - should be significantly higher. In other words: preventing any economic pain now means a much more severe pain in the future. 

In summary: no, interest rate hikes by the ECB will do nothing for today's high energy prices. But next time you hear someone make that argument for the statement that the ECB shouldn't raise interest rates (much), then you should know that that person has no qualms about monetary economics. Although the ECB is not doing anything about the high energy prices with its interest rate hikes, the bank must still raise interest rates. Because not doing so is irresponsible and dangerous for the economy and our prosperity in the long run. 

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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