February 15th, 2011
in Op Ed
by Dirk Ehnts
When central banks look at their policy goals, they find the words ‘inflation’, ‘unemployment’ and ‘growth’ more often than others. Apparently, low (and stable) inflation is good for savers, while low unemployment is good for people offering their labor services and economic growth is for everybody. Follow up:
While this is a bit simplified, nevertheless it is a consensus in macroeconomics. Of course, the recent financial crisis has then caused central banks worldwide to miss their policy goals. Inflation turned into deflation, redistributing wealth from debtors to creditors in some cases, unemployment increased and growth declined. This is bad, of course.
One question that opens up at that point is: how bad? There is a literature strand which is trying to answer this question by looking at the happiness of people and how that is influenced by economic growth, inflation and unemployment. Since central banks – like the ECB - are in a position where they are facing both unemployment and perceived inflation threats (which I will comment on some other day) it would be nice to know how much people are bothered by inflation and unemployment exactly. Heinz Welsch provides an answer:
This paper studies the macroeconomic performance of the EU-12 member countries over 1990–2002 from the point of view of the subjective well-being (life satisfaction) of the citizens. The paper uses data for over 50,000 individuals and controls for personal characteristics (especially income and employment status). Life satisfaction is found to be negatively associated with the unemployment rate and inflation, but positively associated with the growth rate. In contrast to earlier findings, the weights placed on inflation and unemployment are of a similar magnitude.
As unemployment and inflation are both making people sad, and the weights of sadness these issues put on people is the same, what should a central bank do? Let inflation go and unemployment fall, or fight inflation and accept unemployment?
Of course, many things complicate the picture. Demographic plays a role: retired folks would see their life savings disappear with inflation and couldn’t go back to work to regain what is lost. However, young people are robbed of their chances if they stay in persistent unemployment for longer (the NY Times covered this problem in a nice article). The question of who gets what is a question of distribution.
The unemployed get no/less income, the capital owners no/less purchasing power. Therefore, a central bank nowadays is redistributing wealth among the people. This is not what it has been built for. It was supposed to use inflation-targeting to keep inflation low and stable. This was assumed to be enough to guarantee economic growth. We have found out that this is not enough.
The ECB is now between a rock and a hard place. It has to decide who will be unhappy: the unemployed or the capital owners. This decision is not made easier by the fact that the euro zone is quite segregated, with capital owners agglomerating in and around Germany, and the unemployed showing up in peripheral countries like Estonia, Ireland, Spain and Greece. Since Mr Trichet will step down in late 2011, electing a successor will be difficult.
Of course, some countries prefer a ECB president that fights inflation and keeps the euro ‘stable’, while others prefer one who focuses on the countries in distress and is more willing to put the burden of adjustment (inflation) on Germany as opposed to let already-stressed out economies go through a period of deflation. This really is a Sophie's choice situation.
The politics of Europe are in danger to become poisoned by nationalism – the stepping down of Axel Weber might be the first event in a chain of ugly maneuvers of euro zone countries struggling for control. Of course, the president of the ECB is not a dictator – the governing council decides. However, the ECB president will be a symbol of what is to be expected. Europeans should watch carefully how Europe’s top technocrat is (not democratically) elected and what his idea for Europe’s future is. The stakes are high.
The Dichotomy of Currency by Derryl Hermantutz