Promises live on, even if they are not kept. The European Central Bank (ECB) promises the 350 million people in the monetary union that their euro will be worth as much tomorrow as it is today. This is written immutably on its website, as if the past three years had never happened. During this period, inflation rose suddenly to over ten percent, higher than ever before. The powerful central bankers seemed helpless, 350 million people were shocked.
Price pressure has now fallen noticeably. Inflation in Germany was 1.9 percent in August, and 2.2 percent in the euro zone. Next week, the central bank has scope to lower the key interest rate further. Everything seems to be back on track. The monetary authorities are feeling relieved; they believe they are on the right track because high inflation rates are a thing of the past. However, and this cannot be overemphasized, the negative consequences of the price hike remain. The cost of living has risen enormously in the past three years. People notice this when they buy bread rolls and cheese and are reminded that their euro is no longer worth as much as it used to be. Higher wages can compensate for this. But the feeling remains that the monetary authorities have not been able to keep their promise.
The ECB is a privileged institution. The central bankers do not have to be elected by the people; they are appointed to their posts. The salary is high and they are not subject to political instructions. This independence is coupled with the task set out in the EU Treaty of creating an economic environment with stable prices for the 350 million people.
Central banks can conjure up an infinite amount of money, just like that, without a parliamentary resolution. It’s breathtaking. In 2008, US parliamentarians asked the then head of the Federal Reserve whether he could provide $85 billion to save the banks. Ben Bernanke replied dryly: “I can also raise $800 billion.”
Printing a lot of money is one thing. The central bank’s decisions on key interest rates are probably even more effective. The level of the key interest rates sets the basic price for loans, and the monetary authorities use them to control the financial market, the economy and ultimately people’s prosperity. From a democratic theory perspective, this concentration of power is remarkable: one would actually assume that far-reaching decisions such as setting loan interest rates or billions in aid for the financial sector are made by the elected representatives of the people in parliament.
But history has taught us that politicians cannot be trusted to fight inflation. In the 1970s and 1980s, industrialized countries experienced double-digit inflation rates because politicians were more concerned with short-term growth than with long-term price stability. There was a growing realization that independent central banks, which make important but unpopular decisions, are better placed to keep inflation in check. The model for the world was the independence of the Bundesbank, which, politically unmoved, focused on the stability of the D-Mark.
From the 1990s onwards, more and more independent central banks began their work, including the ECB in 1999. At the same time, the fall of the Berlin Wall in 1989, the subsequent collapse of the Soviet Empire and China’s global economic integration triggered a new wave of globalisation. Inflation in the industrialised countries remained low from then on, partly because of the latent cost pressures caused by globalisation and partly because the independent monetary authorities did not do anything stupid. The phenomenon of inflation was forgotten in the following two decades; it seemed to have been defeated, at least in the industrialised countries.
The ECB thought long and hard about whether to raise interest rates at all – a mistake
This is how one can imagine the mood in the towers of the ECB in 2021, when prices slowly began to rise. ECB President Christine Lagarde and her colleagues simply did not believe that inflation would rise sharply. They thought long and hard about whether they should raise key interest rates at all. That was a mistake. However, there were special reasons for the rapid rise in prices. It was a mix that had never been seen before: the economic lockdown to combat the corona pandemic led to supply bottlenecks from 2020 onwards, goods became scarce and expensive. At the same time, governments in the industrialized countries paid out financial aid to their citizens. This money immediately flowed into consumption after the lockdown was lifted – this also caused a price surge. Then Russia invaded Ukraine in February 2022, and energy prices rose exorbitantly.
This mixture of supply and demand shocks resulting from a global pandemic and a global war reflects the new reality that central banks will have to deal with in the fight against inflation in the future. The global economy and its price development have changed fundamentally. Military conflicts, increasing protectionism and climate change have become more influential determinants of the price level. The consequences are measurable: countries bordering a war zone have an average of five percentage points more inflation than others, according to a Study. The same applies to the consequences of climate change: extreme droughts, such as Investigationfood prices can increase by one to two percent.
“Globalization has dampened inflation since the 1990s, but now we are experiencing deglobalization due to the conflict between the USA and China. It is therefore fundamentally more difficult to keep inflation low,” says Jörg Krämer, chief economist at Commerzbank. This also applies to the best central bank. The monetary authorities must be more vigilant and consistent in their decisions; fewer mistakes will be forgiven.
In addition, the ECB, Federal Reserve and other important central banks have been acting as resolute crisis managers since the outbreak of the global financial crisis in 2008. The monetary authorities opened the money floodgates and pumped trillions into the bond markets to save the financial system and protect the euro zone from collapse. Many citizens breathed a sigh of relief, but they were also astonished. Look, the ECB, with Mario Draghi and later Christine Lagarde at the helm, can simply invest trillions of euros. Where does the money come from, and does it have the democratic mandate to do so? Some said not. The purchase of government bonds by the ECB is illegal state financing, plaintiffs argued at the Federal Constitutional Court. The legal dispute underscores how critical parts of society are of certain measures taken by the central bank. The ECB is also not spared from dwindling trust in democratic institutions. This is also due to the side effects of its monetary policy.
Rich people profited from the real estate and stock market boom
During the low interest rate phase from 2013, savings accounts yielded nothing, while property and stock owners, i.e. already wealthy people, benefited from the stock market boom. It’s just like that: households with low incomes cannot afford stocks and real estate. When inflation rose sharply from 2022 and the ECB raised key interest rates, the picture was similar: low-income families suffered particularly from the rising costs of energy, food and services. Wealthy households got through this phase better, especially as the stock markets continued to rise.
These distribution issues are much more socially explosive today than they were 15 years ago, as the debate in this country about the introduction of a wealth tax shows. Monetary policy helped to ensure that rich people became even richer. The current Message Inequality Inc., a study by the development organization Oxfam on social inequality in 2024, shows that the five richest men in the world have more than doubled their wealth since 2020, from 405 billion US dollars to 869 billion dollars. Their wealth has thus grown three times as fast as the rate of inflation. In addition, stock ownership primarily benefits the richest people in the world.
A further distributional imbalance arose because the higher key interest rates primarily benefit Europe’s major banks, which are making billions in profits from their deposits with the central bank, while the trillions of bonds purchased during the Draghi era are now yielding high losses due to the high key interest rates. The Bundesbank posted a loss of around 21 billion euros in 2023, and there will also be red figures in the coming years. The German taxpayer is left empty-handed, while banks and billionaires have benefited from Draghi’s policies. The fact that the ECB is also driving forward the development of the digital euro, which some citizens see as the first step towards a surveillance state, underlines how quickly the ECB’s work is now sliding into sharp social controversy.
The tug-of-war over the central banks could become even more intense. Most eurozone countries and the USA are heavily indebted. Changes in key interest rates by the ECB and the Fed have a direct impact on the national budget. Every percentage point less reduces debt service – and the political pressure to lower interest rates more than might be good is correspondingly strong, always with reference to huge public investment needs in the areas of green transformation, the military and education. “Governing in democracies has become more difficult. Coalitions of three or more parties may not be able to act in an emergency,” fears Markus Brunnermeier, an economist at Princeton University in the USA. “The central bank would then have to bear the brunt of stimulating the economy. In addition, populists could undermine the independence of the central banks, as Donald Trump is showing in the USA.” Times could get even tougher for monetary authorities.
