It was one of the biggest mistakes in the history of the European Central Bank. In July 2008, then ECB president Jean-Claude Trichet raised interest rates – two months before the bankruptcy of the Lehman Brothers investment bank. At the time, Mr. Trichet felt compelled to take action by high inflation that was largely being driven by a skyrocketing oil price.
Eight years later, it is, once again, primarily the price of oil that is driving an uptick in inflation in the euro zone. And Mr. Trichet's successor, Mario Draghi, is also under growing pressure to take action.
The circumstances are entirely different today. The world is not in the midst of a financial crisis. In contrast to 2008, the annual inflation rate in the euro zone is not above the ECB's 2-percent target but in fact, at 1.1 percent in December, still well below. Finally, interest rates today are near zero.
But the fundamental question is the same: Should the ECB react to the short-term effect of a rising oil price?
The central bank's argument is subject to a logical fallacy.
For Mr. Draghi, the answer appears to be a clear no. In December, knowing full well that inflation would rise sharply in the coming months, he extended the ECB's massive bond purchases by another nine months, until at least the end of 2017, albeit with a slightly reduced volume.
He also changed the ECB's yardstick. In the past two years, most thanks to the declining oil price, Mr. Draghi had used the declining inflation rate to conjure up threats of deflation. But now that the oil price has risen sharply again, triggering a rise in the inflation rate, the lower core inflation rate is now being used as the measure of all things, as well as to justify the ECB's aggressive monetary policy.
This core inflation rate, which does not take heavily-fluctuating prices of goods like food products and energy commodities into account, has also risen considerably in recent months. Yet at 0.9 percent, it is slightly more removed from the ECB target inflation of about 2 percent than the overall inflation rate.
This sums up the central bank's argument. But it is subject to a logical fallacy. That's because the 0.9-percent core inflation rate is just as far away from the deflation – or a harmful decline in prices – that is so feared by central bankers. The core inflation rate is at least far enough away from zero that it can no longer serve as justification for the ECB's aggressive intervention and manipulation of markets with its bond purchases.
In 2008, Mr. Trichet was lagging miles behind overall economic development. Mr. Draghi now risks making the same mistake. It's worth noting: The interest-rate turnaround is already in full swing in the financial markets.
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