Look who’s talking: ECB fires a direct warning to workers on wages

“We are sending a clear message to companies, workers and investors: inflation will return to our 2 percent target over the medium term,” Lagarde wrote on July 23 after the bank implemented its first hike in 11 years.

“We will keep raising rates for as long as necessary to bring inflation down to our target over the medium term.”

Whether or not we heed that warning will depend on how much we understand what the ECB is doing and on how much we trust the bank. On both counts, there is a big deficit that goes back to the financial crash.

Central banks like the ECB and the Federal Reserve do like to talk, but it is generally in a conversation with traders and fund managers sitting behind their $20,000-a-year Bloomberg terminals.

It was this audience and not us that former ECB chief Mario Draghi addressed in his “whatever it takes” speech in 2012 that was credited with saving the euro.

Central banks now talk to markets more than they ever have done. In June of this year alone, members of the ECB’s executive spoke more times than they did in all of 2007.

But now it is not the bond traders that the ECB wants to influence, it is us, hence the push on the blog and a revamped series of “explainers” on monetary policy in layman’s terms that have been running – seemingly unloved and unread by most Europeans – since at least 2014.

It is suddenly a matter of extreme urgency.

After a decade in which the too low inflation has been the biggest problem, the sudden shift to a high inflation environment has come as a shock, both to consumers who are now shelling out thousands of extra euro a year for their household bills, and to central banks, who failed to spot the regime shift.

In Ireland, inflation is set to break into double digits this month and it is already there in more than half of the eurozone countries. 

While Draghi did indeed convince market players back in 2012, efforts to explain to us have largely failed.

Just as the ECB embarked on its latest mission to convince the public, a study led by former Federal Reserve vice chair Alan Blinder, who is one of the world’s leading experts on monetary policy, cast doubt on whether central banks can ever communicate effectively with us.

At the very core of central banking is the premise that stabilising inflationary expectations is a chief objective – for the ECB price stability is its only objective.

“But the evidence to date is that central banks have not been very successful in this domain. A minimal goal might be to get the broad public to ‘get the sign right’,” the study concluded.

Yes, you read that right – get the sign right. Central banks have failed at a very basic level when it comes to dealing with the public. The ECB’s own polling reveals that 55pc of eurozone respondents are not interested in what it does. 

“At present, it seems, too many believe that, for example, interest rate hikes probably raise, not reduce, inflation,” the Blinder paper noted.

This isn’t a new problem. Former Bank of England chief economist Andy Haldane spoke back in 2017 about “twin deficits” when it comes to understanding of central banks and our trust in them as institutions.

And surely it won’t have come as a surprise to the ECB that there is a gap that it must remedy.

“Central banks have to be understood by the people whom they ultimately serve. This is a key to rebuilding trust,” Lagarde told her confirmation hearing in the European Parliament in 2019.

Keeping inflation at bay was ranked as the fifth of the bank’s objectives in its poll. Almost four in 10 believe its role is to finance governments – something it is banned from doing.

That price stability mandate is now on the line and the cost of dealing with the current burst of inflation is also rising.

Central banks like the ECB were given operating independence precisely so that they would act as the guardians of price stability. That independence rests on a social contract that is maintained by public trust.

“A loss of trust in institutions is important because it is a breach of that social contract and signals an erosion of social capital,” Haldane said in his speech five years ago. 

So where do we go from here? The revolution that brought us independent central banks in the 1980s also placed them at the heart of managing the economic system, rather than using fiscal policy, ie government spending and borrowing to do so.

Yet the economic orthodoxy of the past 30 years or so seems not to have registered with the public. 

“The picture of monetary policy knowledge that emerges is therefore one of partial knowledge at best and negligible knowledge at worst,” the paper co-authored by Blinder said.

Perhaps inflation will just fade on its own if energy and food prices normalise. If not, it is going to be very costly. 

The economics profession is split. Financial markets in the US are now pricing in rate cuts, perhaps as early as next year.

Larry Summers, who was one of the earliest to warn of inflationary risks, says the US will need a recession to get prices under control and that it will need restrictive fiscal policy alongside monetary policy.

That’s going to be ugly.

“No one wins,” Haldane noted in a piece last year. “Not central banks, whose mandates will have been breached and which would need to ­perform an economic handbrake turn for which they would not be thanked.”