It is now clear that the European Central Bank views higher interest rates as the right response to rising oil prices. As a result, the ECB risks painting itself into a corner, for the logic behind this week’s interest-rate hike implies that more increases will follow – a series of policy mistakes that will cost the Eurozone economies heavily.
Despite statements to the contrary, no central bank, including the ECB, can simply focus on inflation and ignore what happens to economic activity. Suppose, for the sake of argument, that stabilizing prices came at the cost of a 30% unemployment rate. Surely nobody would want that.