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The Threat of Inflation and the Survival of the European Union

Updated on March 20, 2011

European Union the Economic Jig Saw Puzzle

The European Union (EU) is a grand economic experiment on a scale that had been unprecedented. Its creation led to the rise of a formidable economic power that could rival the US and the fast developing China. But its diversity was potentially one of its Achilles Heel that was safely protected until the banking shock of the financial crisis and current inflationary pressures.

The proper functioning of the EU requires the uniform application of policy yardsticks across the different countries with varying economic state of health. The mandatory use of the Euro across all EU countries except the UK means that the individual countries are not able to use currency adjustments to manage the different inflation rates they experience.

Germany Inflation Rate Chart (10 years)

Source

Signs of More Problems on Europe's Economic Horizon

There are definite signs that the EU is experiencing some serious stress fractures. An obvious goal during the creation of the EU was for the economies of the individual EU countries to eventually converge overtime. Unfortunately the unexpected magnitude of the global financial crisis in 2008/2009 led to global inflationary pressures being unleashed during this recovery,

The stability of the unifying structure imposed by the EU is now becoming more of a liability for the individual member nations.

Let's take a closer look at the warning signs. The German economy is booming while some of the peripheral countries including the notable PIGS (Portugal, Ireland, Greece & Spain) are struggling with their recessions. As an example Germany's GDP grew by 2.3 percent in 2011, contrasting it to Greece which shrank 6.6% compared to one year ago. This puts the difference in growth rates between the best and worst performing European countries at close to 9%.

The large difference in growth rates is compounded by the large difference in inflation rates. The unique situations in each country and the different national policies adopted is set to widen this economic divergence. 

Greece Inflation Rate Chart (10 years)

Source

The ECB between the "Rock" of Rising Inflation & the "Hard Place" of Recession

The European Central Bank (ECB) have the difficult task of keeping the single Euro currency intact. It will also be "arm twisted" into adopting loose monetary policies to keep the banks afloat.
There also the conflicting requirement of keeping inflation at just under 2%.

The ECB is trapped in a financial catch-22. If the ECB raise interest rates then the fragile economies might crumble one by one back into recession. If the ECB lower interest rates then it will not be able to control the almost certain rampant inflation rates.

Fingers crossed on whether global economies including the EU can navigate the turbulent inflation prone future.

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