ECB’s Schnabel: Can’t Look Through Energy Price Rises if They Threaten Price Stability
8 January 2022
By David Barwick – FRANKFURT (Econostream) – The European Central Bank may need to ditch the traditional practice of ignoring passing deviations of inflation from its target when these are driven by energy prices, ECB Executive Board member Isabel Schnabel said Saturday.
In a speech at the American Finance Association 2022 Virtual Annual Meeting, Schnabel said that the energy transition was a source of upside risk to the ECB’s medium-term inflation projection.
‘Monetary policy, for its part, cannot afford to look through energy price increases if they pose a risk to medium-term price stability’, she said. ‘This could be the case if prospects of persistently rising energy prices contribute to a deanchoring of inflation expectations, or if underlying price pressures threaten to lift inflation above our 2% target as rising carbon prices and the associated shifts in economic activity boost rather than suppress growth, employment and aggregate demand over the medium term.’
Energy prices have historically often risen and fallen at similar speeds, but the energy transition may limit their ability to decline in the future, she said. This will oblige monetary policymakers ‘to assess whether the green transition poses risks to price stability and to which extent deviations from their inflation target due to a rise in the contribution from energy to headline inflation are tolerable and consistent with their price stability mandates’, she said. ‘[T]here are instances in which central banks will need to break with the prevailing consensus that monetary policy should look through rising energy prices so as to secure price stability over the medium term.’
The technical assumptions underlying the ECB’s central scenario in which high energy prices calm down over the forecast horizon ‘are surrounded by significant uncertainty’, she said, given the poor predictive ability of the relevant futures prices.
Experience does not support the view that energy would not contribute to headline inflation next year and the year after, she said, noting that over the last two decades, the energy contribution to annual HICP was 0.3 point.
‘Sensitivity analysis conducted by Eurosystem staff suggests that it is enough for oil prices to remain at November 2021 levels for HICP inflation in 2024 to reach our target’, she said. The political will behind a massive energy transition suggests this could easily understate actual developments, she said.
‘Potentially protracted supply and demand imbalances related to “transition fuels”, such as gas, as well as the fact that carbon prices are likely to rise further, and to extend to more economic sectors, mean that the contribution of energy and electricity prices to consumer price inflation could be above – rather than below – its historical norm in the medium term’, she said. ‘The energy transition therefore poses measurable upside risks to our baseline projection of inflation over the medium term.’
Should energy prices thus boost inflation for longer than expected, the ECB ‘would need to change course’ in terms of monetary policy ‘if we were to detect signs that inflation expectations have become de-anchored’ or ‘if the nature of the shock were to change’ such that the energy price rise was no longer akin to an adverse oil supply shock, she said.
Either of these could easily occur, she argued. Consumers’ expectations are significantly influenced by frequently purchased goods such as energy, she said. ‘So far, however, there are no signs of broader second-round effects’, she said.
‘But in an environment of large excess savings and protracted supply disruptions, the energy transition may lead to inflation remaining higher for longer, thereby potentially raising the risks of inflation expectations destabilising’, she said. ‘In this case, monetary policy would need to respond to, rather than look through, higher inflation to preserve price stability over the medium term.’
As for the nature of the price shock, the economic transformation of the energy transition ‘is expected to boost, rather than weigh on, economic growth and thereby support wages and aggregate demand’, she said, while ‘[a]n emerging strand of empirical evidence finds no robust negative effects of carbon taxes on GDP growth and employment. If anything, the evidence is consistent with a modest positive impact.’
‘As such, if the future path of energy prices threatens to push headline inflation above our target in the medium term, and if growth and demand prospects remain consistent with firm underlying price pressures, monetary policy needs to act to defend price stability’, she said.