Bizarre Lagardonomics

The Joys of Inflation – Apparently No-One is Safe

Hello everyone, listen up, I had this really splendid idea …

by Pater Tenebrarum

If the papers and sell-side analysts can call the inflationism propagated by Shinzo Abe 'Abenomics', we feel free to call similar policy proposal from the IMF's Mrs. Lagarde 'Lagardonomics'. If we have a free-for-all in which everybody gets to make up his own economic laws on the go, we should probably make clear that this is the situation now.
Mrs. Lagarde heads a vast bureaucracy that would not even exist in an unhampered free market economy and frequently pipes up with her latest epiphanies. She has done so once again last week by making her most recent recommendation for euro area monetary policy public. It is based on the absurd theory (occasionally seen propagated in the editorial pages of the Financial Times, which is per se proof positive of its quackery status) that the best way to make the situation in euro-land as a whole better, is to make the situation in Germany worse.

According to a Reuters report:

“The euro zone may need higher inflation in countries like Germany and lower interest rates across the bloc to ensure a sustained economic recovery brings palpable benefits, the head of the IMF said on Friday.

Speaking during a visit to bailed-out Ireland, Christine Lagarde said while Europe had come a long way since last summer and financial anxieties have eased somewhat, more needed to be done to deal with "depressingly familiar" underlying issues.

Reiterating a call in January for the European Central Bank to keep its monetary policy easy, the former French finance minister said there was room for a further cut after Frankfurt kept rates at 0.75 percent this week.

"Monetary policy should remain accommodative, and we believe that there is still some limited room for the ECB to cut rates further," Lagarde said in remarks prepared for a speech delivered in front of an audience that included Ireland's representative on the ECB governing council, Patrick Honohan.

"Restoring a sense of balance means lower inflation and wage growth in the south (of the euro zone), but it also might mean allowing somewhat higher inflation and wage growth in countries like Germany. This too is an aspect of pan European solidarity."

Lagarde, who has urged countries to press forward with fiscal and reform promises, said on Friday that the pace of such adjustments was crucial and the right balance was needed between putting the books in order and supporting the recovery.” (emphasis added)

Holy here we go again, Batman! What is this, communism light? Make everyone poorer and we'll be a happy family again? The basic idea here seems to be to 'close the competitiveness gap' by not only making the periphery more competitive, but by making Germany less so.

Apart from the fact that it seems an extraordinarily strange idea to do something that weakens the economic well-being of one of the few euro-area countries that still show tentative signs of economic health, the euro area is not an island. Of Germany's 10 largest export destinations, only five are members of the euro area and only two of them – France and the Netherlands – are in the top five. While 57% of Germany's exports are to the wider European Union (the UK is the third largest trading partner after the US), 70% of its imports are from the EU (most from the Netherlands) and only about two thirds of its inner-European trade is with the euro zone. It should also be noted that although Germany is the second largest exporter in the world, its net exports only amount to about 6% of its GDP.

 Germany's net exports as a percentage of GDP via Federal Statistics Department of Germany

 However, all these data are anyway not really meaningful to the argument as such, we provide them merely as background information to show that German trade with the euro zone, while certainly large, is by far not the only concern Germany has with regard to its competitiveness.

Lagarde's argument is essentially that higher “inflation” (read: a faster increase in consumer prices than hitherto) in Germany will somehow be to the benefit of other countries in the euro area. At the root this is a typically mercantilist idea, in that it regards the economy as a zero sum game: only if someone loses, so it is held, someone else can gain.

That the head of one of the world's most prominent and biggest economic central planning agencies can spout such garbage unchallenged is actually quite breathtaking. Economic activity is not a zero sum game. It is not possible to create more wealth by deliberately worsening someone's economic condition. If the money they use loses its purchasing power faster than up until now, Germans will most definitely be worse off than before.

The Euro's Purchasing Power 

Moreover, the members of the euro area happen to use the same currency and are all subject to the same monetary policy regime.  Even if one were give credence to Lagarde's idea and were to assume that it can somehow 'work', it is slightly mysterious how precisely it is supposed to be implemented. If the central bank takes inflationary measures, they will affect the euro area as a whole. Prices will in any event tend toward equality, i.e., the purchasing power of the euro is essentially the same all over the euro area. When considering that money's purchasing power tends to be the same everywhere in regions that are not isolated from each other, one must not lose sight of the fact that what makes goods and services different from each other is not only their inherent characteristics, but also their location.

For instance, the price of a Mercedes car built in Stuttgart will, when it is sold in Athens, be made up of the price in Stuttgart plus transportation costs. A cup of coffee served in the Hotel Sacher opposite Vienna's opera house is not the same good as an otherwise perfectly similar cup of coffee served somewhere in the sticks. In other words, the observed differences in prices stem from the fact that goods that look outwardly similar are in fact not the same goodsin different locales. This does not alter the fact that the purchasing power of money will tend to be the same everywhere.

Mrs. Lagarde did not care to explain how the relatively faster impoverishment of German citizens in terms of the euro's purchasing power was to be accomplished, but as we occasionally point out, it's been a long time since the world has seen luxury miracles performed, so perhaps we are overdue for one.