Germany’s May foreign trade deficit, the first since 1991, is a memorable moment. After all, the conventional view of the euro area is that Germany benefits. As outlined by commentators for decades, Germany’s foreign trade is subsidised by an artificially undervalued currency. German trade competitiveness was a pillar of the standard mental economic geography for decades. So, May’s result is more significant than the similar March numbers for other European Union nations and the bloc as a whole. Given its more lasting character, consequences from this shift in the terms of trade have implications for monetary policy.
One month’s foreign trade results, influenced by sharp energy price increases caused by an unforeseen event, Russian aggression in Ukraine, can be downplayed as temporary. However, some factors pushing energy prices up are more lasting and exclusive to Europe. It is not realistic to bet that this situation will fully reverse. The tense relationship with an aggressive Russia is unlikely to improve and the green new deal is set to stay, meaning Europe will be reluctant to mine for energy resources. After all, the huge Groningen gas field in Netherlands is unlikely to be tapped anytime soon. Europe also has abundant tar sand deposits, but is not willing to exploit them, despite hopes that US finds will alleviate dependence on Russian fossil fuels. The EU is likely to face significantly higher energy prices than most of its competitors and that will worsen its terms of trade.
These worse terms of trade make any significant euro appreciation improbable. Meanwhile, expanded military spending in most EU nations and continuing green new deal investments make fiscal restraint a remote possibility. The ECB will be more or less the only institution capable of limiting more permanent inflationary pressures for years to come. At the same time, it will face operational, political and, perhaps, legal difficulties stemming from its perceived need to restrict euro area spreads in a period of belated rate hikes.
Thanks to this mixture of problems, the ECB’s challenges are much more dramatic than those other monetary institutions experience. In the US, facing a mild recession, the Federal Reserve has already carried out the needed rate hikes. Markets do not doubt its ability to carry out independent monetary policy and restrain inflation in the future. The ECB has been, due to the need to build euro area financial institutions, much more motivated by politics. With 19 euro area members, the ECB faces more dramatic political pressures, especially once monetary restrictions start to bite.
There is another consequence of the ECB not being able to tame inflation, one unimaginable even a few years ago. Despite doubts over the accuracy of the Kremlin’s price statistics, Russia’s sanctions-hit economy exhibits lower inflation than those of its Baltic neighbours, with Lithuania, Latvia and Estonia seeing inflation near or exceed 20%. We are yet to see the economic outcomes of that. They will not be pleasant.
Miroslav Singer is Director of Institutional Affairs and Chief Economist at Generali CEE and a former Governor of the Czech National Bank.