/The central bank is sprinkled with ashes: why the ECB makes so many mistakes in inflation
The central bank is sprinkled with ashes: why the ECB makes so many mistakes in inflation

The central bank is sprinkled with ashes: why the ECB makes so many mistakes in inflation

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ECB – chaired by Christine Lagarde – was Europe’s loudest prophet of how temporary inflation is. How traffic jams in supply chains cannot last long, how food and petrol prices cannot permanently affect people … Until a liter of petrol in most of Europe and for a huge number of people cost more than two euros. And when we talk about hunger in the middle of Europe. Well, then the ECB began to admit that the temporary nature of inflation will be more lasting than they thought, and inflation will be higher than they predicted … Then, after the crown came the war in Ukraine. And now the ECB is writing, “what can explain their latest mistakes in forecasting inflation.” Of course, we deliberately compare the incomparable: how inflation is seen by the central bank and how people’s pockets see it. But in the end, it only matters to people.

First of all, let’s point out that the good news is that the ECB has gone, looked at and found out what’s wrong with their inflation forecasts. and how long it has been wrong. To try to figure out the reasons why it is wrong, and to try to correct mistakes. In the last two tasks, we point out that this is only a good intention, not a success and improvement of the accuracy of inflation forecasts. But still, they admitted – we have a big problem.

1. The biggest mistake in history

The ECB has never been so wrong as it is right now when forecasting inflation. It was close to similar mistakes “only” during the financial crisis. Even this knowledge that models fail during crises was not enough for timely attention and caution.

When the ECB published its inflation projections last December, they have not yet know that this will be the biggest mistake the European Central Bank experts will make. They have never been so wrong in 20 years, never since the first projections of this kind in 1998.

Not only have they announced that inflation is projected to have peaked. in the last quarter of 2021. They also missed out on inflation forecasts in the first quarter of 2022. And they missed out on a lot. The difference between the ECB’s forecast and reality is as much as two percentage points: the forecast was 4.1, the reality was more than 6% inflation. By the way, the end of April is even worse: inflation in the euro area is 7.5 percent

2. How long the ECB’s mistakes have dragged on

The ECB first emphasizes its good work. Inflation forecasts for 2020 were still “quite accurate”, even though the crown had taken place, the ECB boasts. Then the ECB finds that they began to underestimate inflation in the first quarter of 2021. Until the second quarter of 2021, the forecasts were even less accurate, but more accurate than those made by the ECB during the global financial crisis, do not forget to say. Errors in forecasting inflation became increasingly apparent until the third quarter of 2021, after which there was a so-called collapse in projections.

3. We are no worse than others

The ECB points out that other international institutions have made equally big mistakes in their projections for euro area inflation. They all underestimated inflation equally significantly. This further illustrates the important obstacles to forecasting inflation in times of extreme price fluctuations and exceptional economic circumstances.

(EC) The ECB also states that the accuracy of their forecasts is similar to produced for their own economies by the British or American central bank. Nobody noticed such a big jump in inflation in time, and everyone made big mistakes in forecasting inflation for the last quarter of 2021.

4. What are the reasons for incorrect inflation forecasts

The ECB is mainly to blame for unexpected circumstances in energy prices, adding to the effects of the opening of economies after the withdrawal of anti-crown measures and stoppers in supply chains. The ECB emphasizes that the energy prices they include in the calculation of inflation are based on markets and futures contracts. Energy prices and incorrect estimates account for as much as three quarters of errors in the calculation of inflation.

They missed everything: oil, gas and electricity prices. They also misjudged how quickly energy price increases will reach end customers. Contrary to history and contrary to expectations, this happened almost instantly, although historical data show that such a transfer usually takes six months to a whole year.

Recovery and speed of recovery after the crown were also assessed incorrectly, as well as blockages and problems in supply chains, and labor market assessments were also incorrect.

5. Why the ECB’s explanations are like a dog eating our homework

First of all, let’s say that the ECB’s explanations touch on technical limitations in calculating inflation.

However, inflation is not a technical phenomenon. The ECB underestimated and misjudged most of the social, economic and business phenomena that affect inflation. This is a general problem faced by central banks, rating agencies, auditors, appraisers, analysts and others. Modeling, estimates and forecasts are based – which is logical – on performed comparisons of metadata of countless derived products, prices, contracts, instruments. Let’s simplify even more and try to paint: as the ECB says, oil is considered as an oil contract, as an oil market, and no one is going to look at the prices and types at gas stations. Price transfers and the spillover of price increases from wholesale customers to end customers are viewed through historical data, not through the exceptionality of the current situation. They look at the labor market through statistics, instead of going to see how many companies on the street have an ad “we are looking for people”. May 2021 – a year ago, former Finance Minister Larry Summers warned the Fed that it underestimated inflation, among the advice was exactly this, go see where anyone can get a worker.

It is amazing how the ECB clearly assesses and underestimates China’s zero covid policy, which of course has a significant impact on “plugs” and supply chains, on raw material prices, on semi-finished products, transport, services and so on. This is not a temporary health policy of the country, but a control of the people and control of the people, which China obviously needs to maintain communism, the social system. It is not temporary, it is permanent and it has a huge social, business and financial cost, not only for China, but for the whole world. The “stopper” is not just a production, business and financial problem, the “stopper” is a social problem.

It is also worrying how the ECB sees the solution to more accurate forecasts in more detail. assessing and evaluating the energy market in prices, which is of course welcome. However, there is no word on how to evaluate the impact of state aid on prices, on the sustainability of price increases and on the speed of transfers of increases to end customers. Not a word about where the endless printed money is now flowing. Nothing about the monetary financing of countries

As early as 2020, there were – unpopular but clear – warnings of inflation and stagnation after the crown. We also detected and presented them in Finance. Central banks looked elsewhere.

As if attracted by a cat on its tail, so is the ECB’s argument that the assessments and behavior of other central banks are no better. Maybe in the technical calculation. But let us note that at least as early as November last year, the Fed stopped saying that inflation was transient, both central banks – both the US Fed and the British BoE – but raised interest rates. The ECB has reduced only bond purchases, interest rates will not rise at least until the end of the third quarter, when bond purchases will end.

Last but not least, the ECB’s human errors in inflation it symbolically describes this ECB paradox among professionals and people: while the ECB spoke about the transience of inflation, employees and the union at the ECB last November – six months ago – demanded wage indexation, wage increases against persistent inflation. The ECB was not happy with the way people were harassing and naughty.

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