Inflation Is Our Friend: Huh?

Since when was increasing the inflation rate a goal? Not long ago, inflation was an enemy. Rising prices erode your purchasing power. Now, policymakers greet it as salvation. They think it is an antidote to slow growth. It really isn’t.

Curing what ails the European economy will take more than higher prices. But Wall Street reacted to the European Central Bank’s inflation-boosting efforts by setting new records.

Investors widely anticipated action by the ECB since May, when ECB President Mario Draghi announced that the bank was “comfortable acting” at its upcoming meeting. With a report in early June that eurozone inflation was just 0.5%, ECB action was all but certain. Its target rate for inflation is just under 2%.

Anticipation of ECB action helps to prop up the U.S. market at a time when the Federal Reserve is winding down its quantitative easing stimulus program by reducing its bond purchase by $10 billion per month. Apparently, as long as someone is following easy money policies, the markets are happy.

The actions announced by ECB President Mario Draghi did not include bond buying (although there are no eurozone bonds). That’s in keeping with Draghi’s previous actions. He has relied on “forward guidance” to boost European markets and achieve monetary goals.

Forward guidance, as we previously explained, is simply the act of talking about what the central bank will do in the future. Keeping interest rates low, for example, by saying that the ECB will keep interest rates low.

The ECB’s most significant action is to lower the interest rate on bank deposits, including reserve holdings in excess of the minimum reserve requirements, from zero to negative 0.10%.

In other words, banks will pay a fee on money they fail to lend out. Whether or not that stimulates the economy, it could encourage banks to take more risk, approving loans that otherwise they wouldn’t approve. Isn’t that what caused the financial crisis?

The bank also reduced other interest rates. The rate on the euro system’s main refinancing operations dropped 0.10 percentage point to 0.15% and the rate on the marginal lending facility dropped by 0.35 point to 0.40%.

The ECB also aims to encourage lending by giving banks greater access to cash through “a series of targeted longer-term refinancing operations.” That means $545 billion in cheap loans to the banks, provided that they lend more to companies.

Draghi also said, “If required, we will act swiftly with further monetary policy easing.”

Now that’s forward guidance.

You may recall that the Fed has also been trying to increase inflation, which is a huge shift from the days when the Fed’s greatest task was to reduce and control inflation.

Back during the Ford Administration, Americans wore “WIN” buttons, because we wanted to “Whip Inflation Now.” In more recent years, one of the Federal Reserve’s rationalizations for continuing its quantitative easing program was that it wanted to push inflation up to 2%.

The U.S. annual inflation rate finally met the goal of 2.0% for the period ended in April, so President Barack Obama won’t need to consider a “SIN” campaign, for “Start Inflation Now.” The Consumer Price Index jumped another 0.4% in May; since the same time in 2013 overall prices increased 2.1%, spearheaded by shelter, electricity, food, airline fares and gasoline.

So now that inflation has met the Fed’s inflation rate goal, why is the economy growing at a negative rate?

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Brenda P. Wenning is president of Wenning Investments LLC in Newton, Mass. 

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