Despite inflation, the ECB sees no reason to act

Dhe current surge in inflation in the euro area is not forcing the European Central Bank (ECB) to act from the point of view of its chief economist Philip Lane. The price increase for services is weak, the same applies to the growth in wages, Lane said on Monday at an event organized by the Institute of International Finance (IIF). “The trigger for monetary policy action is not there.” For the rise in prices to prove permanent, it must first spread from goods prices to services and wages.

The question is how the ECB should react to the significant increase in monthly inflation rates: Inflation in the euro area was 3.4 percent in September, the highest it has been in 13 years. According to the ECB, a large part of the current price increase is only temporary and caused by the consequences of the Corona crisis.

Differentiate between temporary and permanent effects

At a two-day conference on monetary policy, the ECB’s chief economist dampened expectations that the central bank could react to the higher collective bargaining agreements that are emerging in some euro countries by tightening its monetary policy. Recently there had been speculation in the financial markets that the central bank could let the bond purchases expire faster than expected and then raise interest rates. Lane emphasized that the central bank was closely following the wage settlements in the euro area. However, you will differentiate which of the wage increase is only related to the pandemic. “The distinction between temporary and sustained changes in wage growth will play an important role in assessing underlying inflation.”

In particular, a one-off shift in the wage level, if it is only a response to a temporary, unexpected rise in the price level, does not mean a “trend shift in the course of the underlying inflation,” argued Lane.

Paradox in energy prices

A sharp rise in energy prices alone is no reason for the central bank to tighten monetary policy, said the ECB economist. On the contrary: if energy prices rose abruptly, this could even slow down economic development and thus reduce price pressure in the medium term. “Examining the impact of the current hike in energy prices must take into account the full macroeconomic impact of negative external shocks and supply shocks in the energy sector, including the associated headwinds to economic prospects and the negative prosperity effect that comes with a deterioration in terms of trade,” said Lane. “Through these mechanisms, an energy price shock can simultaneously increase headline inflation, but also exert downward pressure on the development of underlying inflation.”

Meanwhile, the Dutch Governing Council member, Klaas Knot, has warned investors in the financial markets of the risks of a further rise in inflation. Since the beginning of the Corona crisis, players in the financial markets have shown themselves to be much more willing to take risks, said Knot. The riskier investor behavior makes the markets more susceptible to mood swings. The currently comparatively high inflation should be seen largely as temporary. In development, however, there are more things that you don’t understand than things that you understand. Knot added that price pressures could potentially be stronger than previously forecast.

Political tasks for central banks?

The Harvard economist Kenneth Rogoff, meanwhile, pointed out the dangers that could have arisen for the central banks as a result of the closer proximity to the states in the pandemic. Because the central banks are forced by the extremely low interest rates to make more use of bond purchases, there is a greater overlap with the instruments of the fiscal authorities. The central banks would have to be careful not to be just junior partners of the states.

Precisely because the central banks have a great deal of influence and expertise, they are increasingly being asked to perform general political tasks, such as environmental and climate protection. Rogoff said it would not be so problematic if the central banks, for example, used their role as regulators for banks to give more emphasis to goals that were set by the democratically elected institutions.

If, on the other hand, they dare to set their own goals, there would be credibility risks if the central banks were involved in areas that were “only thinly linked to their mandate and their expertise”.

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