ECB’s Panetta Sees Little Chance of Sustained Inflation Above 2% in the Medium Term

24 November, 2021

By David Barwick – PARIS (Econostream) – European Central Bank Executive Board member Fabio Panetta on Wednesday argued for continuing to deploy monetary policy to safeguard the recovery and restore pre-pandemic trend economic growth, a condition in his view for price stability, and said he saw ‘little chance of sustained inflation above 2% in the medium term.’

In a speech at French university Sciences Po, Panetta said that ‘we are now in an environment of two-way inflation risks’ and that the ECB’s ‘focus needs to be on the risk that inflation in the medium term turns out persistently lower or higher than our 2% target, rather than on short-run developments.’

However, Panetta argued that the euro area was much more subject to supply constraints than other major economies, and that temporarily high inflation was effectively a ‘tax on consumption and a brake on production, over time generating effects akin to an adverse demand shock.’

Monetary policy should bide its time as long as the price spike doesn’t lead to ‘destabilising’ second-round effects, he said. Indeed, he suggested a possible need to provide further accommodation in rejecting ‘passively tolerating an undesirable tightening in financing conditions.’

‘We should remain focused on completing the recovery, returning GDP to its pre-crisis trend, as the condition for achieving self-sustained inflation at our target in the medium term’, he said. ‘To this end, we should keep using all of our instruments for as long as warranted, with the necessary flexibility to support the transmission of our policy stance throughout the euro area on its uncertain path out of the pandemic.’

Panetta acknowledged the possibility of surprisingly persistent inflation, though such an outcome ‘would exacerbate risks in both directions’ from a medium-term perspective, he said. ‘Providing the risks are not excessive on both sides, a steady hand – preserving the prevailing stance of monetary policy – should be the preferred course of action.’

Even in the event of surprisingly persistent inflation, he said, ‘there is little or no evidence at this stage to suggest that they would feed into wage-price spirals or a de-anchoring of inflation expectations in the euro area.’

Rather, he maintained, they could harm the recovery and weaken underlying price pressures. ‘All in all, on the basis of the available information, there seems to be little chance of sustained inflation above 2% in the medium term’, he said.

Panetta rejected the idea that the pandemic was over and expressed opposition to ‘an inappropriate, sharp reduction of purchases’ of assets. ‘Net asset purchases will continue to be an essential ingredient of our monetary policy stance even if the pandemic emergency purchase programme comes to an end’, he said.

He urged that ‘the flexibility that has served us well in past months should become an integral element of our asset purchases’ and to ‘not tolerate any financial fragmentation which could impede the transmission of monetary policy throughout the euro area.’

The medium-term balance of risks depended on the likelihood of a wage-price spiral, but the currently negative output gap in the euro area renders this improbable, and there is still labour market slack, he said. Although this doesn’t exclude wage pressures, neither the lack of a broad-based skill mismatch nor the tame outcomes of wage negotiations observed so far suggest these will emerge, he said.

‘Wage growth is expected to pick up as the recovery matures, but we should not be alarmed if we see signs of a one-off catch-up in wages next year’, he said. Appropriate unit labour cost increases over the medium term are ‘critical for 2% inflation to become self-sustained’, he said.

However, an expected post-pandemic increase in productivity will limit higher wages’ impact on unit labour cost growth, he said.

Downside economic risks ‘may be growing’, he said, voicing concern about ‘the risk that a long-lasting negative supply shock prevents the economy from reaching full capacity.’ The negative impact of supply constraints on future economic activity ‘may soon become visible in actual GDP growth’, he said.

At the same time, more expensive energy could reduce spending on non-essentials and influence hiring, while the resurgent pandemic might also weigh on activity and restrain wages, he said.

‘We do not have the legitimacy to do so’, he said when asked during Q&A about prospects for the ECB to employ so-called helicopter money. ‘This is a prerogative of governments.’