Tomas Hirst on the State of ECB Policy and the Eurozone Economy

Episode Summary

Executive Summary: This episode examines the Eurozone’s post-pandemic economy and the ECB’s tightening cycle. Thomas Hurst argues Europe’s inflation is mostly energy- and supply-driven, not demand-led, and that ECB hikes risk overcorrecting into a weaker growth outlook. He is more optimistic about new EU fiscal integration, but skeptical that inflation expectations or wage spirals justify aggressive tightening.

Main Topics: Post-pandemic Eurozone recovery and demand dynamics (Priority: 5/5): Hurst compares Europe’s reopening to the U.S., noting lockdowns were longer and more stringent, but pent-up demand and excess savings still boosted consumption. He stresses that Europe’s private demand has recovered far less robustly than the U.S. European fiscal response and the Next Generation EU package (Priority: 5/5): The discussion highlights Europe’s furlough schemes, which protected jobs but still reduced incomes, plus the centrally raised Next Generation EU recovery fund. Hurst sees this as a meaningful step toward shared fiscal capacity and crisis backstops. ECB mandate, governance, and interest-rate instruments (Priority: 4/5): Beckworth and Hurst review the ECB’s Governing Council structure, the equal vote of member states, and the shift in market focus from the main refinancing rate to the deposit facility rate in an abundant-reserves system. Why the ECB is tightening (Priority: 5/5): Hurst explains the ECB’s concern that high headline inflation could de-anchor expectations, even though it is largely energy-driven. He argues the bank is reacting more to optics and reputational risk than to domestic inflation pressure. Wage dynamics and labor-market differences versus the U.S. (Priority: 5/5): Unlike the U.S., Europe lacks strong labor-market churn and job-switching wage gains. Hurst says European wage settlements have been more moderate and do not yet show a wage-price spiral, despite union bargaining power. FX channel and imported inflation (Priority: 3/5): The ECB’s concern about euro weakness and a strong dollar is discussed as a secondary reason for tightening. Hurst says FX pass-through may matter short term, but it is not a strong basis for aggressive hikes in a weak-demand environment. Policy implications and framework critique (Priority: 5/5): Hurst urges gradualism, suggests the ECB should be less aggressive than markets expect, and even recommends considering an NGDP-style framework to better discipline expectations and avoid unnecessary welfare losses.

Key Arguments: Europe’s recovery has been less demand-overheating and more supply-constrained than the U.S.; nominal demand is only roughly back to trend, with private demand still weak. Pandemic support in Europe was less inflationary than in the U.S. because furlough schemes reduced income relative to normal earnings, unlike U.S. transfers that sometimes exceeded prior wages. Next Generation EU is a major institutional shift because it created centralized borrowing and cross-country transfers, improving the Eurozone’s crisis-response capacity. The ECB’s inflation fears are understandable, but inflation expectations and wage bargaining have not shown clear evidence of de-anchoring or a wage-price spiral. European labor markets are structurally different from the U.S.: less churn, more union bargaining, slower wage pass-through, and therefore weaker evidence of domestically generated inflation. ECB rate hikes will affect member states unevenly because mortgage structures differ sharply across the Eurozone, making policy transmission asymmetric. Aggressive tightening risks creating a snap-up/snap-down cycle in rates and unnecessary recessionary damage, especially as energy inflation is already likely to fade naturally. FX considerations may justify some tightening, but are insufficient to explain sustained hawkishness when underlying domestic demand is weak. The ECB should prioritize gradualism and accept that inflation will likely fall back toward or below target in 2024 even without extreme policy. Hurst views some ECB arguments as earnest but mistaken: central bankers are trying to do what looks credible, not necessarily what data justify. The Eurozone’s evolving fiscal architecture may be one of the few positive structural outcomes of the crisis, moving the bloc closer to a real shock absorber. Using central-bank balance sheets as a de facto mutualization tool is politically contentious, which is why centralized fiscal issuance is important.

Data Points: ECB deposit facility rate: from -0.50% to 1.50% - Hurst describes the ECB’s hiking cycle and notes the deposit rate is now the key reference rate in an excess-reserves system. Expected ECB move in December: 50 basis points - Hurst says another 50 bps hike is essentially certain at the upcoming ECB meeting. Fed rate increase this cycle: 375 basis points so far, with another 50 basis points expected in December - Beckworth contrasts the Fed’s faster tightening with the ECB’s slower start. Eurozone headline inflation: over 10% year on year - Hurst cites this as the reason the ECB became more concerned about expectations and credibility. Eurozone core inflation: about 5–6% - Used to explain why ECB officials shifted away from “looking through” temporary shocks. Negotiated wage settlements in Europe: around 4% this year, falling to 3.5% next year - Hurst uses this to argue against a wage-price spiral narrative. Mortgage share with loans outstanding: roughly 30% of households in Germany; over 60% in the Netherlands; 18% in Italy - Illustrates how uneven monetary transmission is across the Eurozone. Floating-rate mortgage share: around 25% in Spain; near all mortgages in Ireland are floating or reset within 0–5 years - Shows why some countries feel ECB hikes much faster than others. U.S. mortgage structure: 30-year fixed rates dominate - Beckworth uses this to contrast the U.S. with Europe’s more immediate mortgage transmission. ECB market pricing: another 100–125 basis points of hikes - Hurst says markets expected more tightening than the Fed had left at the time. Germany auto sector: still below pre-pandemic volumes - Evidence that supply-chain disruptions continue to affect industrial activity. Europe’s savings trend: no clear excess-savings windfall visible in demand data - Hurst argues the usual excess-savings story is weaker in Europe than in the U.S.

Pivotal Quotes: "there's nothing so permanent as a temporary solution" — Thomas Hurst: On how the Eurozone tends to evolve through crisis-driven fixes and why Next Generation EU may become a lasting fiscal feature. "I believe that they are arguing in earnest. I believe that they are arguing in error." — Thomas Hurst: His characterization of ECB officials’ inflation concerns and tightening rationale. "we're going to keep beating you until things break" — Thomas Hurst: His critique of the ECB’s large-rate-hike strategy and its impact on households and growth.

Implications: If Hurst is right, ECB tightening will cool inflation mainly by weakening growth rather than fixing a demand problem. Europe may emerge with stronger fiscal integration, but also with unnecessary recession risk if policymakers overreact to an energy shock.