ECB Watch: Issing Changes Tack To Stagflation
--------------------------------------------------------------------------------
12:44 ET
=DJ ECB Watch: Issing Changes Tack To Stagflation
12 Dec 12:44
By Charlene Lee
Of DOW JONES NEWSWIRES
FRANKFURT (Dow Jones)--Exasperated. That's how European Central Bank chief
economist Otmar Issing might be feeling, with all this alarmist talk about
deflation.
And it could well explain why he has recently dredged up an alternative
specter: stagflation - a dangerous cocktail of stagnating economic activity and
rising prices.
Last seen in the early 1980s, it leaves central bankers between a rock and a
hard place. Interest rates can't be lowered to stimulate growth without further
stoking inflation. Nor can they be raised to put a lid on rising prices without
choking off the economy.
For the time being, "the risk that we might enter a lasting phase of low
growth with more or less strongly rising prices, which could be called
stagflation, deserves much more attention than the risk of deflation," Issing
said in a London speech early last week - just days before the ECB slashed
interest rates by 50 basis points.
Issing hammered the same message home in an interview published Wednesday by
German news agency VWD.
On the surface at least, the ECB's latest batch of twice-yearly forecasts
Thursday seems to point to conditions that suggest stagflation.
Euro-zone growth this year will hit 1.0% at best, while inflation will remain
just above the ECB's targeted 2% ceiling. For 2003, projections for growth were
slashed sharply to 1.1%-2.1% from the 2.1%-3.1% projected just six months ago.
Despite this weaker outlook, inflation prospects haven't declined. The bank
envisages prices will rise next year by 1.3%-2.3%, which is hardly changed from
the 1.3%-2.5% projected in June.
Far Cry From Late 70s-Early 80s
Economists, for the most part, agree with the ECB's view that deflation,
typically defined as a continuous decline in prices, isn't really a threat to
the euro zone at the moment. However, Issing's assertion that stagflation is a
greater risk is also being greeted with skepticism.
"For the short term he's right," said Fortis Bank euro-zone economist Elwin
de Groot. "But for the medium term - and in the end that's what monetary policy
should address - most indicators are pointing towards easing inflation
pressures."
Certainly, large chunks of the euro zone, notably Germany, are stagnating,
but the stagnation isn't uniform.
"We're not talking about a situation that's comparable to the 1980s or 70s,"
said UBS Warburg senior economist Holger Fahrinkrug. "I think the real economic
risks are to the downside - and probably for inflation too, if you strip out
oil."
The current mix of weak growth and stubborn inflation is still a far cry from
the stagflation that began in the late 1970s and ran into the next decade. In
those days inflation, exacerbated by the oil shock, was well into the double
digits. Central banks then had less independence and generally pursued overly
accommodative policies alongside highly stimulative fiscal policies from
governments.
Economists note just how patchy current conditions are from sector to sector.
Falling prices and virtual recession in manufacturing fits the deflation risk
arguments. In services, however, upward price pressures persist despite
weakening demand, which to a degree fits the stagflation mold.
Counterpoint
For the euro area as a whole, based on the ECB's latest projections, "it
seems to me to be neither deflation nor stagflation," said Norman Williams,
economist at Barclays Capital.
Issing, some observers ventured, may have simply wearied of constantly
downplaying the deflation risk and tossed out the word "stagflation" to shift
the debate. ECB officials are asked about deflation at just about every public
appearance. In recent weeks, there's been a spate of research notes focusing on
deflation - and they largely conclude that risks may have risen somewhat in
Germany. But for now it's unlikely, either in Germany or the euro zone as a
whole.
Stagflation, Williams noted, is "a useful counterpoint to a lot of the
discussion that's going on."
And maybe it's not all that surprising that Issing, who was chief economist
at the German central bank before taking up the ECB post, would regard
stagflation as the more serious threat. It was, after all, the stagflation
episode of the late 1970s that prompted several central banks, including the
U.S. Federal Reserve, to take the monetarist line during the 1980s.
That approach, which targets money supply, has long since been abandoned by
most central banks, although the Deutsche Bundesbank was arguably the last
major holdout. Today the legacy is enshrined in the ECB's two-pillar philosophy
to setting rates, with a controversial first pillar that gives prominence to
monetary developments.
Issing also happens to be the staunchest defender of the monetary pillar. "I
consider it very dangerous to underestimate the monetary side. No central bank
can afford to neglect the monetary side," Issing told VWD.
-By Charlene Lee, Dow Jones Newswires; +49 69 297 25 500; charlene.lee
(END) Dow Jones Newswires
12-12-02 1244ET |
