“Europe will be forged in crisis and will be the sum of the solutions adopted for those crises.” These words from the memoirs of Jean Monnet, one of the architects of European integration, echo today, as Russia closes its main gas pipeline. This is surely now a crisis. Whether Monnet’s optimistic perspective prevails, we do not know. But Vladimir Putin has assaulted the principles on which postwar Europe was built. He simply has to be resisted.
Energy is a vital front in his war. It will be costly to win this battle. Yet Europe can and must free itself from Russia’s chokehold. This is not to underestimate the challenge. Capital Economics argues that at today’s prices the worsening of the terms of trade would amount to as much as 5.3 per cent of Italy’s gross domestic product over a year and 3.3 per cent of Germany’s. These losses are bigger than either of the two oil shocks of the 1970s. Moreover, this ignores the disruption to industrial activity and the impact of soaring energy prices on poorer households.
It is inevitable, too, that sharply rising energy prices will lead to high inflation. The experience of the 1970s indicates that the best response is to keep inflation firmly under control, as the Bundesbank then did, rather than allow desperate attempts to prevent the inevitable reductions in real incomes to turn into a continuing wage-price spiral. Yet this combination of large losses in real incomes with less than fully accommodative monetary policy means that a recession is inevitable.