04/17/24 | IMFS: News

The ECB and Its Watchers XXIV: Uncertainty about the inflation path ahead

The end of the inflation surge, monetary policy transmission and the banking system and the implications of geopolitics were at the heart of the debates during the conference „The ECB and Its Watchers XXIV“ when central bankers, financial market participants and academics discussed current issues of monetary policy and financial stability.

In her opening speech at this year's conference on March 20, ECB President Christine Lagarde said that the European Central Bank cannot commit to further rate cuts after a likely first move in June. She said that "when it comes to the data that is relevant for our policy decisions, we will know a bit more by April and a lot more by June." She added that "we are not yet sufficiently confident that we are on a sustainable path towards our inflation target."

In the debate on the inflation surge and the lessons for monetary policy, ECB chief economist Philip Lane emphasized that core inflation was coming down more slowly than historically, which called for paying particular attention to service prices. In his intervention, Richard Clarida from Columbia University brought in an American perspective, examining the development of the rate of inflation in the United States. Regarding the lessons of the inflation surge since 2021, he said that central banks should be more focused on inflation expectations. "I would put more weight on surveys," Clarida said who served as the 21st Vice Chair of the Federal Reserve from 2018 to 2022. Evi Pappa from the Universidad Carlos III stressed the increase in inflation volatitliy and the differences between the development in the euro area and the U.S. due to "the ECB's additional constraint: the geopolitical uncertainty in the euro area" after the Russian attack on the Ukraine. "In times of uncertainty, monetary policy is weaker," she said.

Concerning the monetary policy transmission and the banking system, Pablo Hernández de Cos, Governor of the Bank of Spain, pointed out that the transmission of the current monetary policy tightening cycle to private-sector financing conditions had been forceful and, in some cases, stronger than expected on the basis of historical regularities. In his view, a stronger than expected monetary policy impact remains a downside risk to the euro area growth outlook. "We should calibrate the degree of monetary restriction accordingly to the materialisation of such risk," Hernández de Cos warned. Mariassunta Giannetti of the Stockholm School of Economics focused on central bank reserves and bank lending. Regarding quantitative tightening, she said that consequences of shrinking central banks‘ balance sheets were hard to predict as reserve holdings are „an optimal choice of banks“ and „banks with more lending opportunities could optimally choose to hold more reserves“. Looking back at the banking crisis in the U.S. in 2023 when Silicon Valley Bank, Signature Bank and First Republic Bank suddenly collapsed, Axel Weber warned against a "vulnerability we haven't overcome yet". The former President of Deutsche Bundesbank who was a Chairman of the Board of Directors of the major Swiss bank UBS between 2012 and 2022 was rather skeptical of banks with a "concentration problem" based on a very narrow business model.

In the debate on geopolitics and the implications for inflation and monetary policy, ECB board member Isabel Schnabel focused on the question "whether the recent reversal is a sign that real interest rates will remain higher once the impact of recent shocks has faded, or whether they will return to the lows seen in the pre-pandemic era." In her speech, she concluded that "we need to thoroughly examine whether the fundamental forces driving the economy over the long run have changed, and communicate these views prudently." Vítor Gaspar, Director of the Fiscal Affairs Department of the International Monetary Fund, pointed out that geopolitics followed a particular logic that was different from the economic logic. In his view, the increased salience of geopolitics calls for a European response. Furthermore, he said that the European Single Market "is a precious asset for competitiveness and growth". Clemens Fuest, President of the Ifo Institute, described how geoeconomic challenges coincide with other negative supply shocks. He sees various long-term effects of geoeconomic fragmentation for EU sectors. According to Fuest, implications could be costly. "Geoeconomic fragmentation may reduce EU real income by 1 to 5 per cent, depending on scenario," he said.

Source: IMFS