European inflation is different from US inflation

Indeed, central banks on both sides of the Atlantic have not been quick enough to spot the current price rises. But that is no reason to lump the US and the eurozone together. In America, the outlook for inflation is fundamentally worse, says French economist Jean Pisani-Ferry.

In short

• European governments behaved like insurers during the pandemic, protecting workers and employers from a devastating shock.
• US policymakers are still wondering why 2.7 million workers disappeared during the crisis.
• Moreover, the US financial aid packages were overkill.

In the Eurozone, consumer prices in December were 5% higher than a year earlier and in Germany, the number of Google searches for ‘inflation’ was three times higher than normal; in France even ten times higher. So it is easy to get the impression that Europe – like the United States, where prices rose by 7% – will have a tough time fighting the inflation monster.

The ECB, which for too long dismissed concerns about price rises by arguing that deflation was the main risk, is now on the defensive, as is the US Federal Reserve. Critics say the ECB is dangerously lagging behind the inflation curve and that the bank has neglected its main task of ensuring price stability. Some say that after years of adventuring with quantitative easing, doomsday has arrived.

Central banks on both sides of the Atlantic are certainly to blame for failing to spot the current price rises early enough, but that is no reason to lump the United States and the eurozone together. The widespread view is that inflation has returned for good on both sides of the Atlantic. But in reality, the outlook for the US is fundamentally worse, for three reasons.

Overkill in support

The first is that the US under Donald Trump and under his successor Joe Biden has countered the effects of covid-19 with massive fiscal stimulus measures. The amount of money transferred to households and businesses from March 2020 to September 2021 – in the form of special tax breaks, unemployment benefit top-ups, debt forgiveness and other measures – amounted to an unimaginable $2.5 trillion, or over 11% of pre-crisis GDP.

It is true that part of this amount was necessary because the strong, built-in shock absorbers that have been common in Europe for so long were missing in the US. For example, the extra unemployment benefits were needed because standard benefits were low and short-term. But the US financial support packages were overkill. And as former finance minister Larry Summers and economist Oliver Blanchard argued a year ago, too much financial support was bound to lead to major imbalances. Given the historically low unemployment rate before the corona crisis, there was no hope that output could keep up with the extra demand created by the aid policy.

More generous and more economical

Paradoxically, Europe was both more generous and more thrifty. When French President Emmanuel Macron announced in March 2020 that workers forced to go home because of the pandemic would continue to be paid, he said loud and clear that the state would fulfil its protective role, “whatever the cost”. Not everyone in Europe said it so clearly, but almost all governments followed a similar policy. For a while, there were no more budget restrictions; where necessary, the ECB even helped governments out.

Citizens were understandably astonished by this generosity. But the French compensation scheme ended up costing only 1.4% of GDP, even though at one point as much as 40% of the working population applied for it. As the number of infections dropped and people went back to work, the use of the compensation scheme also decreased. All in all, the total support package to households and businesses cost about 3% to 4% of GDP. In contrast to the US, Europe did not use money indiscriminately to cope with the economic problems of the pandemic. Household incomes in Europe were maintained, but not increased. Therefore, there was no huge increase in demand.

Keeping the contract and conditions

The second reason is that workers who were sent on leave in Europe because of the pandemic kept their employment contracts and the accompanying working conditions. Yes, temporary and stand-by workers, self-employed workers and those on temporary contracts paid a high price during the coronary crisis, and newcomers to the labour market also had a hard time. But overall, European governments acted like insurers, protecting workers and employers from a devastating shock.

So it is no surprise that the European labour force, now that the worst seems over, has remained largely intact. US policymakers, on the other hand, are still wondering why 2.7 million workers disappeared during the crisis and how to solve a multitude of bottlenecks in an economy that suffers from both surplus demand and shortage of supply.

In both Europe and the US, many are considering changing jobs, employers or sectors and many companies are struggling to find staff. But that is not the same as withdrawing from the labour market. In retrospect, the European model has proved more effective than the US in ensuring continued labour force participation.

Hasty change of course

The final reason why the inflation threat in the US is more worrying comes from the fact that the Fed had explicitly said it wanted to keep its powder dry. In August 2020, Fed Chairman Jerome Powell unveiled a new strategy whereby, after a period in which inflation had been below the 2% target rate, policymakers would allow it to stay above 2% for a while, while aiming for “maximum employment”. The quid pro quo for this bold change, of course, should have been responsible fiscal policy. But now that Congress and the President have done exactly the opposite, the Fed is forced to make a hasty change of course.

Certainly, the ECB is also facing restrictive circumstances. Everyone wonders whether Italy, whose public debt has exploded to 155% of GDP, will still be able to place government bonds with investors if the ECB starts to wind down its bond-buying programme. But in any case, the ECB itself has not set any restrictive conditions.

Europe more effective

Ten years ago, Europe’s response to the financial crisis was disastrous. But Europe, with a more effective social model and more targeted financial support measures, has tackled this crisis better than the US. And while Europe certainly has its own problems to tackle, neither European policy issues nor solutions are identical to those in Washington. Laurence Boone, the chief economist of the Organisation of Developed Countries (OECD), recently told eurozone finance ministers that there is no need for tighter fiscal policy, nor is there any reason at this stage to fight high inflation, caused mainly by high energy prices, with aggressive interest rate hikes.

In many Western economies, inflation is higher than it has been for decades, but the picture is not the same everywhere. With US inflation fever increasingly gripping markets, European policymakers need to keep a cool head and focus on what they need to do.

Jean Pisani-Ferry is a senior fellow at the Brussels-based think tank Bruegel and a senior non-resident fellow at the Peterson Institute for International Economics. He holds the Tommaso Padoa-Schioppa Chair at the European University Institute.