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One of the pioneers of European Central Bank monetary policy has a stark warning for officials about the threat of more inflation bearing down on the region’s economy.
Otmar Issing, the former Bundesbanker who became the first chief economist of the Frankfurt-based institution in 1998, reckons further consumer-price pressures may already be in the pipeline.
“I expect that we will see wage increases, which will create new inflation shocks,” the 86-year-old German economist said in an interview in his study in Würzburg, 120 kilometers away from the Frankfurt home of the ECB.
The remarks by a veteran policymaker synonymous with hawkishness are all the more poignant after a week when data showed underlying consumer-price growth in the euro zone at a new record high.
Worry about persisting pressures is prompting officials to vow further aggressive increases in borrowing costs even after 300 basis points in hikes since July. In recent days, investor bets showed for the first time an expectation for the ECB’s deposit rate to reach 4%.
Surrounded by books including The Inflation of 1923 by Frank Stocker — a tome on the crippling hyperinflation of Germany’s Weimar Republic — Issing has harsh words for the failure of the ECB under President Christine Lagarde to have kept consumer prices in check.
“To act early is the best approach,” he said. “The ECB missed that by quite a lot.”
Issing’s warning of renewed consumer-price surges reflects his analysis that there’s more to the current shock than simply an energy spike caused by the war in Ukraine — a view of the world that Frankfurt officials don’t tend to dwell on.
“Inflation was already under way before it was exacerbated by the war,” he said. “I never understood why the ECB for so long neglected that inflation was rising.”
Issing’s legacy in developing the central bank’s founding two-pillar framework, featuring both economic and monetary analysis, remained largely intact until it was modified as part of a strategy review a couple of years ago.
His reputation as the ECB’s original and archetypal hawk, a standard-bearer of the Bundesbank mantra of price stability on which the euro-zone institution was founded, also still resonates in Frankfurt and elsewhere.
Just how much became apparent in late 2021 when newly appointed Bank of England Chief Economist Huw Pill — a former ECB official — told the Financial Times that he was “quite proud” to be “identified as an acolyte of Otmar Issing.”
Issing’s arrival at the fledgling ECB, after spending the 1990s on the Bundesbank board, was the culmination of a career spent in academia. He was tasked with establishing the basic framework for the newly created central bank as it ushered in the euro.
He recounts discussions behind the first decision to set the bank’s price stability goal as inflation below 2% — now revised to 2% – which would impact monetary policy decisions for years to come. Many had suggested something higher or even no official target at all.
“It was a very challenging time, with small staff and a huge task before us, which was not at all certain,” Issing said.
A frequent critic of the ECB in recent years, notably under Mario Draghi’s leadership during the past decade, there’s a lot about its policies that Issing would have done differently.
For one, forward guidance — attempting to steer market expectations by making pledges on future policy stances, for example by not raising rates — isn’t his cup of tea.
“You give orientation, but not details,” Issing said. “Markets will tend to understand conditional statements as unconditional.”
Quantitative easing, another flagship policy of the Draghi years, both showed its prowess and its limits, he reckons.
“QE worked quite well at the start, but then as we move into further phases, there is little or no impact,” Issing said. “The negative side effects will dominate.”
One legacy is that central banks are “overloaded” with government bonds, and that balance-sheets shrinkage — a process the ECB is only just starting — is “badly needed,” he said.
“It’s hard to imagine that a new round of QE could start from the present level,” Issing observed.
Gallic Wars
The octogenarian economist displays the vigor of a younger man, driven by his love of academic research. He is reading Julius Caesar’s Commentaries on the Gallic Wars, with a German translation nearby in case his Latin gets rusty.
Looking back on his own life, Issing recalls growing up in the same city where he now resides, set in the rolling Franconian hills of northern Bavaria, at a time when it had been reduced to rubble by Allied firebombing.
Somehow, Würzburg still managed to flourish and retain its beauty. Similarly, the creation of the ECB, and its existence as an institution where people speak all European languages, seems to him miraculous when thinking back to the horrors of World War II.
Almost a quarter century since he first became one of the guardians of the euro, Issing ponders the future with more than just inflation on his mind. He sees the integrity of the single currency as still vulnerable to the whims of governments willing to stretch public finances.
“Monetary union cannot survive if you don’t see responsible fiscal policy in all member countries,” Issing said.
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