Why the Commission is not afraid of stagnant inflation

By Tasos Dasopoulos

Not in the scenarios that are spreading and want the energy crisis in Europe to develop into stagflation, says the Commission, arguing that the different structure of Europe’s economy leaves no room for a repetition of the consequences of the oil crises of the 70s and 80s.

In a special chapter of her summer forecasts, she recalls that stagflation began with the Yop Kippur War in the early 1970s, leading to the first oil crisis, which was repeated with the Iranian revolution, bringing in between 12 years of low growth and high inflation. In relation to this difficult period, the Commission identifies three major differences between those oil crises and today’s energy crisis, which is also fueled by the consequences of the war in Ukraine.

The first big difference is the use of fossil fuels in today’s European economy. As emphasized, the intensity in the use of fossil fuels and especially oil in the industry has been significantly reduced and a part of the production gets the energy it needs from RES. A key structural change for the EU economy is that from the 1980s to today, it has shifted much of its activity from the secondary sector, i.e. manufacturing, to the tertiary sector, i.e. services. All this resulted in the EU’s dependence on fossil fuels being reduced by 33% over the last 25 years. The decline is greater in Central and Eastern European countries, which have been more dependent on fossil fuels than the European average.

The labor market

A second major change identified by the Commission is the secondary effects on inflation created by wage increases that followed price increases. The change in the way wages are now determined, with increases not directly linked to rising inflation as they were then, leaves room for maneuver in difficult times like the one we are going through. Today’s linking of wage growth with employment growth and job retention has prevented the current crisis from creating a so-called spiral of price-increasing effects, i.e. a feed-back inflation. Along with wages, product and service purchases were made more flexible and competitive through reforms.

The central banks

A third parameter that differentiates 2020 from 1970, is the fact that Central Banks no longer have as their main mission the maintenance of exchange rates as they did then, but the maintenance of price stability. In this matter, namely in aiming at price stability, the ECB has gained credibility in the intervening years since the introduction of the euro as the common European currency. It is even emphasized that the collective intervention of the largest central banks in the direction of price stability shows that monetary policy is very different today than it was 50 years ago.

The features of 2020

However, the Commission admits that the higher public and private debt that did not exist in 1970 and is the result of historically low lending rates for more than a decade, will make the exercise of anti-inflationary monetary policy more complicated. At the same time, it does not rule out pressures for wage increases for specific sectors of the economy. He emphasizes, however, that after two years of the pandemic, the accumulated deposits of households can smooth out the pressures of revaluations.

Finally, it is pointed out that the precedent with the pandemic has helped to create a series of support mechanisms that normalize the situation and help more the weakest. In this category he mentions the SURE initiative, to boost employment, the InvestEU initiative and of course the Recovery and Resilience Fund which are in the arsenal of the United Europe and can also be used in the current crisis.