ECB’s Lane: Extensive Accommodation Needed for Inflation Pressure to Accumulate

8 November 2021

By David Barwick – FRANKFURT (Econostream) – A high degree of monetary accommodation remains warranted by the inflation outlook, European Central Bank Chief Economist Philip Lane said on Monday.

In a speech at the ECB Conference on Money Markets, Lane reminded of the ECB strategy’s emphasis on ‘especially forceful or persistent monetary policy action’ near the effective lower bound, and called the medium-term assessment of weak inflation ‘compelling’.

Negative demand shocks and positive supply forces before the pandemic have had a ‘persistent impact on price- and wage-setting dynamics’, while fiscal policy in the medium term is limited by high indebtedness and the lack of centralised fiscal authority, he said.

‘These factors reinforce our strategic assessment that extensive monetary accommodation is required to ensure that inflation pressure builds up on a persistent basis in order to stabilise inflation at 2% over the medium term’, he said.

Lane identified three factors behind currently elevated HICP that would subside during 2022: the rebound from the pandemic’s impact and the policy response; supply bottlenecks, which he said had an ‘inherent temporary component’; and energy prices, whose inflation contribution ‘is typically stronger in the near term than in the medium term, also due to the adverse macroeconomic impact’.

‘Taken together, these three forces explain why inflation is temporarily high and provide solid reasons to expect inflation to decline through the course of next year’, he said.

With respect to the ECB’s reaction function, ‘it is always necessary to keep in mind that monetary policy affects the inflation rate only with a considerable lag’, he said. Tightening policy today would have no rapid inflation impact but would impede the recovery and thus ultimately dampen medium-term price pressures, he said.

This would be ‘counter-productive’, given medium-term forecasts that already show the ECB undershooting its target, he argued.

The ECB’s forward guidance establishes three conditions for policy tightening, he reminded, and safeguards against a policy reaction to developments seen fading away within the projection horizon.

The condition with respect to underlying inflation implicitly acknowledges that ‘it is critically important to filter out the temporary impact of base effects and bottlenecks on goods inflation and services inflation’, he suggested.

Wage developments adjusted for productivity and ‘differentiating between transitory and persistent components’ would be of key importance in evaluating underlying inflation, he said. ‘In particular, a one-off shift in the level of wages as part of the adjustment to a transitory unexpected increase in the price level does not imply a trend shift in the path of underlying inflation.’

Asset purchases also help provide the necessary level of monetary accommodation, he said. By extracting duration from the market, the purchases compress term premia and contribute to guiding longer-term yields and keeping financing conditions appropriately favourable, he said.

The ECB does not concentrate on its central scenario to the exclusion of other potential outcomes, he said, and is thus mindful of the risk that supply constraints and energy inflation could hinder the recovery.

‘At the same time, if persistent bottlenecks feed through into higher than anticipated wage rises or the economy returns more quickly to full capacity, price pressures could become stronger’, he said. ‘However, economic activity could outperform our expectations if consumers become more confident and save less than currently expected.’