Page 21 - Aequitas Europa EU Law Project 2017/18 For educational purposes only

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A possible answer for why strong growth and demand is The ECB will likely react to any security-price inflation by
not having a proportionate effect on inflation is that using credit policies other than monetary policy.
Europe has been experiencing sudden, positive increases However, they would argue in all probability that this type
in the supply of goods and services which affects price of inflation is unlikely given the current increases in supply
equilibrium and, on a macro level, the economy’s general which have subdued inflation. But for all that is said about
price level. These sharp increases can be created in many the supply increases being temporary, and that
ways, for example, the globalised economy producing productivity and strong employment will eventually
cheaper goods and services from emerging markets; redress low inflation, why do we not hear more confident
ineffective workers’ unions with little influence to noises from the ECB about easing the money supply? Is
negotiate higher salaries for its members which means this a tacit admission that in private the ECB
that there is less of a relationship between acknowledges supply increases could be here to stay?
unemployment and inflation; advances in technology It is unlikely that the ECB is going to give up the 2%
(principally IT) which are reducing the costs of goods and inflation target. Instead they will probably increase the
services. timeline to achieve the target rather than revise it
downwards. This does suggest that they accept inflation
Conventional wisdom dictates that monetary policy will will remain low for a longer period, otherwise the bond
change if these positive increases in supply continue. If purchasing programme would need to continue for
the increases are ephemeral then the ECB should not longer and interest rates would remain at zero percent in
react and instead maintain its monetary policy drive perpetuity. This is a policy which other central banks have
because as the increases stop, and productivity and the in recent months distanced themselves from (the Bank of
supply of labour is maintained, inflation will begin to rise. England and the FED).
On this basis it is reputed that the ECB is preparing to The ECB may eventually succumb to downgrading its
gradually reduce its bond purchasing programme in 2018. inflation target as continuing with a less orthodox
However, if the increases do continue then Draghi’s policy monetary policy could create an environment of inflated
could become ‘looser and looser’. asset prices, unsustainable borrowing and ultimately a
bubble which is the catalyst for economic decline. The
And then what could happen if the increases are ECB is currently juggling a number of risks and it will
sustained? Maybe the ECB should abandon the standard continue to do this as long as inflation remains low.
approach to gradually increasing the money supply in
consideration of different initiatives, for example, Student:
reducing the reserve requirements banks need to adhere
to so they have more money to lend or issuing bonds with M.M.
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lower coupons which deter investors from parking their
money in debt so instead it remains circulating in the

economy. In all likelihood continued supply increases will
mean an even greater commitment to the standard
approach as it becomes a necessity. The ECB will have to
commit quickly, otherwise the rate of inflation would be
conforming to a new standard – a lower inflation target.
So what could a lower inflation target mean for Europe?
Certainly the need to rely on monetary policy to control
inflation would be reduced and this in turn would have
less of an impact on the price of high-risk securities which
can create economic bubbles through speculation. Such
eventualities can be thwarted by a quick and sustained
adherence to the standard approach which could help
stave off another financial meltdown.