To inflate or not to inflate (2): But what happened during the early days of the Euro?

The introduction of the Euro in The Netherlands was cause for much discussion. In my article of Monday September 5, “Sketches of Spain”, I already referred to these discussions:

It is a commonly heard opinion that the exchange rate of the Dutch guilder to the Euro should have been about 2 to 1, instead of the 2.20371 that it actually was. I subscribe to this opinion. However, would the former have happened, than this would have put pressure on the Deutschmark (GED). This currency was actually too expensive, compared to the NLG, if you looked at the economic strenght of both countries at the time. For political reasons this didn’t happen and the exchange rate got set on the current rate.

The results of this political horse trade for the Dutch consumer was a price explosion in Residential Real Estate, in prices for hotels, café’s and restaurants and for daily (especially food-related) consumer goods, like bread, potatoes, rice, vegetables and meat.

Today I want to dig deeper in this subject. I want to look back at the days when the exchange rate for the Euro was set and I want to look at the inflation since the Euro has been introduced as a cash currency, based on data collected by the Dutch Central Bureau of Statistics (www.cbs.nl).

The rate was set on 31 December 1998 after a series of secret, multilateral meetings between the Finance Ministers of the Euro-zone. Instead of the earlier mentioned, realistic and defensible exchange rate of ± 2 NLG = €1, Finance Ministers Gerrit Zalm of The Netherlands, Oskar Lafontaine of Germany and the other ministers negotiated an exchange rate of  €1 =  DEM 1.95583  and NLG  2.20371. As the Guilder and the D-Mark were connected like siamese twins in those days and the Dutch finance minister followed the German finance minister closely in all financial decisions, this seemed like the right solution.

However, in fact the Dutch economy was much stronger than the German economy in those days, as the Germans still suffered from the financial consequences of the unification process between West- and East-Germany. The Germans were only just finding their way up, due to the introduced policy of wage restraint, that was advocated by Gerhard Schroeder.

At the same time, the Dutch economy operated at full steam. The Dutch had their period of wage restraint already some years behind them and the country’s workforce was mean and lean. Therefore, the Dutch Guilder should have been valued higher than actually happened.

Complicating factor in those days was that the Euro existed only on paper, as a non-cash currency. The Dutch people didn’t care about the Euro yet and even for many companies (probably except banks), the new exchange rate was ‘just a figure’ that needed to be processed in all computer systems. Compared to the dollar, the Euro was very cheap in those starting days ($1 ≈ €1.10), but nobody cared then about that ‘virtual money’.

During the introduction period of the Euro (1999-2002), it was officially forbidden by the government to raise prices when the Guilder prices of products and services had to be recalculated to Euro-prices. If a product or service had a price of NLG 2.99, the Euro-price should be €1.36 and not one cent more. The only price increases that were allowed, were increases due to rising raw material prices and normal inflatory price increases.

Therefore companies, municipalities and stories held their horses and waited until the cash Euro was introduced.

The ‘no price increases’ policy changed in the months after the Euro introduction on January 1, 2002.

All companies, stores, non-profit organizations and government bodies that had been ‘silent as a mouse’ during 1999-2002, took their chances. Especially the food, beverage and hospitality industry took ‘this chance of a lifetime’ to kick their prices skyhigh in the months after the introduction of the Euro. But also all other products and services have become much more expensive, since then.

Pessimists in those days complained that the purchasing power of €1 would soon be the purchasing power of NLG 1 in 2000. Although I was not that pessimistic in those days, I must fully admit now that these pessimists had been right.

To give you an impression of the prices changes in The Netherlands, I collected some prices from my memory and compare those with the current prices. This method is of course not scientific, but it gives a good impression:

Product or Service	Price in 2000	Price in 2011
1 Loaf of Luxury Bread	NLG 2.10	€ 1.90
1 beer on a popular terrace	NLG 3.25	€ 2.75
Average meal pp at Chinese Restaurant	NLG 15	€ 12.50
A portion of French Fries with mayonnaise or ketchup at a snackbar (Dutch fast food-restaurant)	NLG 2.00	€ 1.75
A small Dutch snack at a snackbar	NLG 1.50	€ 1.40
Average meal pp at other restaurant	NLG 35	€ 35
A bottle of soft drinks 1500cc	NLG 1.50	€ 1.25
Average small service at city hall	NLG 15	€ 12.50
Average large service at city hall	NLG 100	€ 80
Liter of gasoline	NLG 2.00	€ 1.60
A week’s amount of groceries for a 5 people family	NLG 135	€ 110
An average single family dwelling	NLG 220,000	€ 220,000
A gentleman’s haircut at an official hairdresser	NLG 25	€19
A two-way trainticket for 30 km	NLG 13.00	€ 9.50
Parking for an hour in Amsterdam	NLG 3.50	€ 4.50

With these price changes, you have to keep in mind that most wages didn’t increase at the same level since 2000. To look at my own situation: in 2000, I earned about NLG 5500 gross per month; now I earn about €4600 gross per month. I did this, however, by changing my job for a number of times, thus earning a much higher basic salary. Besides that, I’m now much more experienced in what I do and therefore a much better and productive employee.

Many more Dutch people have not been that lucky; while everything around them became much more expensive, their wages did not increase equally. This led to a de facto-loss of purchasing power.

The thing that hurts most people the most nowadays is that the subsequent governments always categorically denied that there had been substantial inflation, while the people instinctively knew that this was true.

The Dutch Central Bureau of Statistics (www.cbs.) writes a few pages on this subject in their review of the Dutch economy in 2010 (link in Dutch). I will write here some pertinent snips of this report, followed by my commentary:

The reality behind the inflation rate

Of all the data that the CBS publishes, the inflation rate is one of the most highbrow figures.

Inflation is a recognizable phenomenon and influences everyday life. Where economic growth and unemployment are quite abstract concepts to many people that keep their job, the inflation is on everybody’s crosshairs. Inflation has significant financial consequences for almost every Dutch person. Not only directly, due to price increases on goods and services, but also indirectly. With the development of consumer prices, also rents, taxes, subsidies, allowances, wages and pensions are indexated.

As inflation is very close to everyday practice, the concept is often subject for discussion. This was clearly recognizable after the abolishment of the NLG in 2002 and the rise of the food and fuel prices in 2008 and 2010. Many people thought that real inflation was much higher than the statistical bureaus claimed, since the price of their daily groceries rose much harder than the official statistics claimed.

Although it doesn’t acknowledge it, at least the CBS understands that many Dutch citizens saw their personal inflation as well beyond the official inflation mark.

Highlights of the CBS article:

·         Prices in the category communication dropped by 7.6% during the last five years

·         With 12.5%, the prices of insurance products rose above average

·         For pensionates and independent workers the prices rose by an average 9% during 2006-2010

·         Receivers of welfare experienced price increases of 7.7% during 2006-2010

·         Workers experienced an average price increase of 8.2% during 2006-2010

·         Since 2001, the prices at restaurants and cafés rose by an average 3.1% per year.

·         In January, 2002 alone, the prices at restaurants soared by 3.1% compared to one month earlier.

·         The  price-increase of a glass of beer in cafés and restaurants since 2001, was 4.7% per year

·         At supermarkets and specialty stores the price-increase since 2001 was 2.1% per year

·         In the period 2001-2010, the inflation for routine-purchases (food and daily consumption products) was 0.5% above the normal inflation rate. This effect was reinforced by a raise of the Dutch VAT (Value Added Tax) in 2001 and the introduction of the Euro in 2002. The supermarket wars in 2004 and 2005 had a dampening effect on prices.

·         The highest differences between the routine and non-routine purchases can be found in 2008 and 2010, when soaring commodity prices on the international markets led to rising food and fuel prices.

This is a really good article by the CBS and as a matter of fact, the whole report is a good read for everybody with sufficient knowledge of Dutch.

At least it explains partially why the experienced inflation for many people is much higher than the official inflation. What is not investigated during this research, is the influence of local circumstances on prices.

It is a fact that the Amsterdam area is much more expensive with almost everything: housing, parking, hotels, restaurants and café’s and everyday costs of life. This might cloud the vision of its inhabitants.

A second fact is that rural areas in general are (much) cheaper for the same categories [housing, parking, hotels, restaurants and café’s] than the larger city-areas. This makes sense and it makes also sense that people living in those cities experience a higher personal inflation than the inhabitants of the rural areas.

What is less common knowledge, but has a substantial effect on the experienced inflation, is that many municipalities use their citizens as ‘lenders of last resort’.

When you have a deficit in your city’s budget:

·         Increase parking rates or introduce paid parking

·         Deliver less service for the same amount of money

·         Increase rates for building permits, commercial permits etc.

·         Increase rates for waste and sewerage taxes

·         Increase rates for vital services like passports, id-cards, birth certificates, driver’s licenses etc.

·         Increase property taxes

·         Increase prices for building ground.

As prices for municipal services differ from city to city and village to village, the country-wide spreads for the same services and taxes are sometimes amazing (up to a factor 5 in spreads for the same building permits or waste and sewerage taxes).

I don’t know of course if the inflation in The Netherlands would have been different when the exchange rate of the Euro would have been NLG 2,-. This makes this a very hypothetical discussion.

But it is a fact that there has been substantial inflation for a lot of products and services in The Netherlands. And it is also a fact that there is sometimes a very strong correlation between this inflation and the introduction of the Euro.