What will Lagarde surprise us with soon? Christine Lagarde, the president of the European Central Bank (ECB), has long trivialised the rising inflation. In February, however, she suddenly acknowledged the issue of the rising inflation, and stated that a rise in interest rate cannot be excluded in 2022. A week later she surprised us again, by attenuating her previous statement. Ivo Arnold, Professor of Monetary Economics at Erasmus School of Economics, argues why Lagarde’s unpredictable behaviour may deteriorate the trust and stability of the financial system.
Communication
Arnold argues that a central banker should not be unpredictable but exude trust and stability. To do this, a central banker should be able to practice clear and stable communication. According to Arnold, this is something Lagarde is not yet sufficiently developed in.
Tough situation
The Professor explains the reasons for the change in Lagarde’s behaviour. Before the war in Ukraine, the economy was booming and therefore in need of a higher interest rate. However, with the war in Ukraine, ECB’s task is not so straightforward anymore. The rising energy prices are excess abating the inflation issue on the one hand. The war in Ukraine on the other hand, is causing the European economies to experience lower growth rates. Thus, the ECB is facing a dilemma, raising the interest rate may increase the inflation issue, but this would increase the chance of a pending recession. Additionally, raising the interest rate may enlarge the panic on the already frightened financial markets. Arnold concludes that the ECB should focus on their primary task; price stability. The ECB should thus continue with the normalisation of the monetary policy, including a raise in interest rate.
Structural crisis policy
Arnold stresses that the war in Ukraine is not the sole reason for the difficult situation in which the ECB finds itself. The ECB has constantly neglected to close the money supply after a crisis. This has led to investors and governments of the Southern European countries to become addicted to free money. This structural crisis policy that the ECB has been practicing, has also deteriorated investors’ and households’ trust in the ECB’s willingness to tackle inflation.
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For the whole item by Professor Ivo Arnold, 16 March 2022, click here.