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Inflation and Recession – Why did the ECB raise interest rates in record numbers?


At its meeting today, the Central Bank Council of the ECB increased all interest rates by 0.75 percent. This is intended to combat inflation; is, however, a problematic step in an incipient recession. And then there are the bailouts from the eurozone countries…

An analysis by Dagmar Henn

The European Central Bank increased all of its interest rates today by 75 basis points, or 0.75 percent. There has not been a comparable increase since the ECB was founded, i.e. since the introduction of the euro. The usual step by which central banks raise or lower is 25 basis points; 50 was expected, ie an increase in interest rates of 0.5 percent.

Simultaneously explained the ECB: “Based on the current assessments, the Central Bank Council expects to raise interest rates further at the next meeting in order to dampen demand and protect against the risk of a sustained upward movement in inflation expectations.” The goal of monetary policy remains to lower inflation within the euro zone to the target margin of two percent.

“According to Eurostat’s preliminary estimate, inflation hit 9.2 percent in August. Soaring energy and food prices, demand pressures in some sectors as the economy restarts and bottlenecks in supply chains are still driving inflation. (…) To the Looking ahead, ECB staff have revised their inflation expectations significantly upwards and now expect an average of 8.1 percent for 2022, 5.5 percent for 2023 and 2.3 percent for 2024.”

At the same time, a slowdown in growth and stagnation in the fourth quarter of 2022 and the first quarter of 2023 are assumed. “Very high energy prices are reducing the purchasing power of the population’s income and bottlenecks in supply chains, although easing, continue to limit economic activity.”

This statement proves that the ECB knows how problematic this step is. The tasks of the ECB are limited to pure monetary policy; This means that their measures are based solely on inflation, not on economic data, as most central banks in Europe used to do. This is a limited problem as long as the inflation/deflation and growth/recession cycle runs parallel, which is the norm – when there is an economic crisis, people spend less, so demand is lower, and so inflation falls , while in a boom they demand more and inflation rises as a result.

However, the current situation is characterized by a number of special features. On the one hand, at least consumer demand has been massively weakened by the high energy prices, as confirmed by the ECB itself. On the other hand, thanks to the lack of energy caused by the sanctions, all production is at the beginning of a massive downward spiral. So there is not only a falling demand, there is also a falling supply. However, inflation that does not result from a surplus of money, but from a falling supply, cannot be controlled by monetary policy, which the US Fed also recently admitted.

A coincidence of inflation and recession (known as stagflation) last occurred in the early 1970s, triggered in part by the oil crisis when OPEC countries cut oil supplies. So the trigger is similar to that of the current crisis. Economic policy reacted to this state of affairs by turning to the neoliberal policy that characterized the last few decades: the dollar’s link to gold fell, statutory interest rate caps were lifted, as were various statutory regulations that limited speculative transactions. This step was no longer sufficient in the financial market crisis after 2008, despite interest rate cuts to zero, whereupon the central banks, especially the Fed and the ECB, started buying government debt directly. After that, there were several attempts in both the USA and the euro zone to raise interest rates again, which soon had to be reduced again.

Neither demand nor supply are infinitely flexible. A level of demand necessary to sustain life cannot be fallen below, at least with the resources of the central bank, and a supply that cannot arise due to a lack of material prerequisites (energy) cannot be generated even by lower interest rates.

The only ones who are asking for large amounts of money in the current economic situation are the states, which are distributing money in the form of large rescue packages to dampen anger about energy prices, but on the one hand this means higher interest rates for the loans taken out have to pay, but on the other hand counteract the possible effect of an interest rate hike on the inflation rate itself.

More on the subject – At the Expense of Others – The USA on the brink of national bankruptcy


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