ECB’s Schnabel: Supply Shocks Delaying Return to Price Stability

29 February, 2020

By David Barwick - LONDON (EconoStream) – A more generous definition of the European Central Bank’s policy-relevant medium-term horizon could conceivably be appropriate in view of supply-side shocks that hamper the restoration of price stability in the euro area, ECB Executive Board member Isabel Schnabel suggested Friday. In remarks at the Barclays International Monetary Policy Forum, a copy of which the ECB made available, Schnabel said the possible mid-term economic impact of the coronavirus was subject to great uncertainty at the moment. With the U.S. having become the largest oil producer in the world and, more generally, oil prices’ impact on underlying inflation having diminished in recent decades, the contribution of the cost of energy to inflation has weakened, she argued. At the same time, a trend toward higher profit margins has facilitated companies’ ability to ignore short-term input price developments that they would have previously been more inclined to pass on to consumers, she said. These two structurally important factors impede the transmission of monetary policy to inflation, obliging central banks “to exercise more patience in reaching their inflation aim, in particular when approaching the effective lower bound,” she said. “This implies that the medium-term horizon over which the ECB pursues the sustainable alignment of inflation with its aim is considerably longer than in the past.” Arguing against such a lengthening of the time horizon relevant for ECB policy is the fact that “central banks are limited in the extent to which they can ignore such shocks without risking a destabilisation of inflation expectations,” she said. Indeed, monetary authorities may actually need to stop looking through short-term developments and “shorten the horizon over which inflation should be brought back to their aim.” When interest rates approach the lower bound, however, a shortening of the relevant time horizon could accentuate the financial stability risks of loose policy, she cautioned. In such an environment, it is essential that central banks understand well the potential for second-round effects, including the relationship between expectations and measured inflation, and that they be thoroughly aware of the financial stability risks of unconventional measures, she said. “These efforts will be an important part of the ECB’s ongoing strategy review,” she said. In other comments, Schnabel noted that “the dramatic events around the spread of the coronavirus have increased uncertainty about the global growth outlook, and also the outlook for the euro area. But very little is yet known about the potential medium-term implications.”