Interview with Henrik Müller: Economist: “The shock from the Ukraine crisis is greater than the stagflation in the 1970s”
Berlin The Ukraine crisis is having a negative impact on the economy, while at the same time causing energy prices to rise significantly. Henrik Müller, Professor of Economic Journalism at the Technical University of Dortmund, even considers a development like the great stagflation of the 1970s to be conceivable.
The main reason for this is the limited ability of the European Central Bank (ECB) to act, which is unable to react properly to rising inflation due to the economic strain: “We can’t afford a debt crisis now.”
According to Müller, there are some indications that the high inflation will become more entrenched. This is shown by the inflation early warning system I-Index developed by him and other Dortmund scientists together with the Handelsblatt. This shows that there are likely to be significantly higher wage demands to compensate for inflation. A wage-price spiral “like we haven’t seen in decades” is possible.
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Read the full interview here:
Mr Müller, the ECB has tightened its monetary policy slightly, but is leaving all options open. The right step?
Yes, in view of the dramatic situation, a cautious approach is definitely the right tactic. However, the ECB has put itself in a difficult position. Since the fall, it has watched the rising inflation rates for far too long without taking countermeasures. She relied on dealing with a temporary phenomenon. The Russia-Ukraine crisis is now triggering what is believed to be the greatest shock of uncertainty in generations, which is weighing on the economy, while at the same time price dynamics are picking up speed across the board. The job of the ECB has become extremely demanding.
More about the new economic indicator I-Index:
The ECB still has a clear mandate: to ensure stable prices.
Yes – but it must also ensure financial stability. It’s a difficult balancing act. The ECB is now effectively part of the deterrent strategy the West is using to try to contain Russian aggression. Should individual euro countries have financing problems, the ECB will not be able to stand by and watch. We cannot now also afford a debt crisis. The war and the threat of further geostrategic escalation are changing the role of the central bank. We have seen this many times in history. Fighting inflation will be given top priority again when the military situation eases – hopefully soon.
Inflation in recent months has already been determined by supply shocks, particularly due to rising energy prices. Surely the ECB can’t influence that?
Correct. But not only energy and raw materials have become more expensive. Since the autumn we have seen that the price dynamics are spreading, mainly due to supply bottlenecks. It would have been time to scale back the securities purchase program that the ECB launched in the wake of the corona crisis and to prepare for a tightening of monetary policy in terms of communication. That happened too late.
However, many economists do not consider a growing money supply to be inflationary at all.
It doesn’t necessarily have to be either. But if the massive expansion of liquidity that has occurred in the course of the Corona crisis programs also meets supply shocks, it would be surprising if this did not have an inflationary effect. We saw something similar with stagflation in the 1970s. At that time, too, various central banks did not initially recognize the weakened growth in production potential. It looks like this error is repeating itself now. The ECB, but also the US Federal Reserve, have sat back and relaxed for far too long, relying on inflation rates to fall again through no fault of their own.
Do we have to prepare ourselves for a scenario like in the 1970s?
I think that’s realistic. The shock we are experiencing now from the Ukraine crisis is greater than in the 1970s. We are in a situation of extreme uncertainty. The term “turning point” used by Chancellor Olaf Scholz after the Russian invasion should prove to be very comprehensive.
However, stagflation like in the 1970s only occurs if inflation becomes entrenched.
The so-called second-round effects are decisive for this, i.e. when higher prices lead to rising inflation expectations, which entail further price increases. So far, however, we have not seen anything of the decisive second-round effect – rising wages to compensate for the higher prices, which will drive up inflation again. Not yet. But our new inflation indicator, the I-Index, signals that the topic is at least under discussion.
Together with other scientists from the Technical University of Dortmund, you have developed the I-Index, which now appears regularly in the Handelsblatt.
It is an indicator that analyzes reporting on inflation – and is therefore intended to depict something like society’s inflation narrative. Which causes of inflation and which consequences play a role in the debate? Who is to blame for rising prices? The I-Index is based on an algorithm-based analysis of three million newspaper articles spanning more than two decades. Whether rising inflation rates will become entrenched will be largely determined by consumer and business expectations. The media play a not inconsiderable role in the formation of expectations. This can be crucial, especially for wage demands.
So what does the I-Index show now?
In February, the topic of wages appeared three times more frequently in the I-Index than six months ago. The value is now higher than at any time in the past 20 years. In fact, it would be surprising if, in the face of rising consumer prices, unions did not try to protect workers’ purchasing power. This speaks for significantly higher wage demands. It’s possible that we’ll get caught up in a wage-price spiral that we haven’t seen in decades.
What does this mean for the monetary policy of the ECB?
Communication is now part of the central banks’ toolbox. They are trying to influence expectations. This also means that they should have as objective a picture as possible of the communicative environment in which they are encountering. Indicators like the I-Index can help with this. So far we have only calculated the index for Germany. However, we plan to further develop the I-Index and expand it to other euro countries. This could be of particular interest to the ECB, which as a supranational central bank is confronted with a large number of public debates and wants to influence them.
Why should you use media reports for this analysis? Social media determine the discourse at least as much.
We are looking for the right measuring points at which the anatomy of public discourse can be traced. Traditional media, especially newspapers, are still suitable for this. Current research results show that debates in social media are also reflected in traditional media – and vice versa. At the same time, we can create time series based on established media brands, which allows us to visualize long-term developments. This is not yet possible with social media. But the media landscape is changing dynamically. We will have to check again and again whether these basic assumptions still apply and adjust our instruments accordingly.
More: The I-Index – the new measurement of inflation