ECB – The overdue strategy update

The ECB is currently reviewing its monetary policy strategy, which aims to ensure low inflation of 2% in the medium term. President Christine Lagarde, however, has played down the strategy review. That is surprising. After all, the current monetary policy strategy with the possibility of massive government bond purchases is based on the questionable assumption that deflation, i.e. a broad-based fall in consumer prices, is much more dangerous than inflation.

No deflationary downward spiral in the data, ...

However, the Bank for International Settlements (BIS) shows that there are no signs of the often mentioned downward spiral of falling prices and consumers' hesitation to spend. During the gold standard in the four decades before the outbreak of the First World War, economic output regularly rose, although consumer prices often fell. It can also be shown for the period since the end of the Second World War that the economy has grown, even if consumer prices had fallen in the meantime. This also applies to Japan, whose per capita income has increased by 0.8 per cent per year since 2000 despite interim drops in consumer prices.

The only counter-example are the years between the First and Second World Wars. During that time, both the economy and the price level collapsed in the USA. This went down in economic history as the Great Depression. However, the fall in consumer prices was not the cause of the economic misery, but a symptom of a deeper problem. Trapped in the gold standard, the US Federal Reserve had failed to provide the faltering banks with the necessary additional liquidity after the Wall Street crash in 1929. As a result, around a third of US banks went bankrupt. The resulting destruction of bank deposits caused the money supply to collapse and pulled down both consumer prices and the output of companies that could no longer obtain credit. The Great Depression was therefore caused by a flawed liquidity policy on the part of the US Federal Reserve and not by falling consumer prices.

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