3 things that will help reduce the sting of high inflation, unemployment and weak growth
Most economists believe that the combination of high inflation, unemployment and weak growth pose the worst possible scenario for the European economy. If so, the next few months might seem like a good opportunity to introduce reforms that will help to reduce the pain and uncertainty that these developments are causing. In our view, that opportunity is fast slipping between our fingers, but not before we have tried to explain what these reforms should look like and how they should be implemented. Here are three key reforms that we believe should be part of any reform package that aims at helping to prevent the collapse of the current fragile economic upswing.
1. Define inflation and unemployment correctly
I am not surprised that the European Central Bank does not have a clear cut inflation target as long as it is not clear how inflation is to be measured. It is often difficult to get an inflation rate from the bank, because the bank relies on the calculation from the BIS’s price index. It is therefore not clear who would measure inflation. Instead, it is likely that it will be a combination of the government and the IMF. The IMF has a price deflator which is used to calculate inflation. So the government is using this, which is based on the price index. The government is not always as consistent as it should be. If it does not agree on the numbers, we are stuck with a target that has no meaning. We are also stuck with government bond yields that are below yields in other developed countries. This is an indication we are still at the stage of a temporary economic recovery.
The inflation rate is currently at 5% and it will probably be near 4.5% when the figures are published in the third quarter of 2012. We do not have a clear inflation target, except that it should be more than the 2.5% that the BIS is targeting. We know from experience that high inflation is damaging to a fragile recovery. It leads to higher interest rates, which means much more pressure on public finances, and it reduces the real value of money, which makes it harder for an economy to grow. In the long run, high inflation hurts companies and households, which are