Money and Markets

One of the euro’s founding fathers says the ECB is 'living in a fantasy' about inflation

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Euro notes
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  • Otmar Issing said the European Central Bank's slow response to inflation posed a risk to growth, in an interview with the FT.
  • One of the euro's founding fathers, he said the ECB had "lived in a fantasy" and downplayed the risk of rising prices.
  • Inflation has surged to record highs in the eurozone, but the central bank has not yet raised interest rates to tackle it.
  • For more stories, go to www.BusinessInsider.co.za.

One of the founding fathers of the euro believes the European Central Bank has been far too slow in responding to inflation and risks tilting the single currency bloc into "stagflation", where prices continue to rise, while growth slows.

Otmar Issing, who was also the ECB's first chief economist in 1998, rebuked the central bank for downplaying the risk of soaring inflation and not tightening monetary policy fast enough to deal with it.

"The ECB lived in the fantasy of continuing this policy without any negative consequences," he told the Financial Times in an interview. "They would be in a better, or at least a less bad, situation if they had started to normalise policy before, the war should not distract from this fact."

Issing said the ECB had misjudged the factors that have caused the surge in inflation."The ECB has contributed massively to this trap in which it is now caught because we are heading towards the risk of a stagflationary environment," Issing said. 

Annual eurozone inflation jumped to record highs of 7.5% in March, up from 5.9% the month before. Skyrocketing energy prices contributed significantly to inflation, as Russia's war with Ukraine sent commodity prices soaring.

The ECB will hold its next policy meeting on Thursday and has signalled it is concerned about inflation, but economists said the threat to economic growth and rising energy prices and the uncertainty around the impact of the Russia-Ukraine war might affect how aggressive it is in tightening monetary policy.

"The risk is that the ECB will probably not validate the July pricing of a potential rate hike just yet because of uncertainty over the growth impact from the Russia-Ukraine conflict," Jordan Rochester, a currency strategist at Nomura, said.

The ECB maintains a target rate of 2% for consumer inflation, but has struggled since the sovereign debt crisis to achieve it.

Issing said the ECB's forecasting model for inflation was outdated given the current situation and was based on the past and cyclical experience. "You need a much broader approach to explaining inflation in a time of structural changes. If you have a misdiagnosis, of course, you have a misguided policy," he told the FT.

He said the ECB had been too slow to rein in its ultra-loose monetary policy. Other central banks like the US Federal Reserve and the Bank of England have already raised rates to tackle inflation, however the ECB will scale back its monthly asset purchases faster.

"It is obvious the ECB is late to react, while the Fed might be even more behind the curve," Issing said.

"Inflation was a sleeping dragon; this dragon has now awoken," he said.

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