ECB Insight: Schnabel Forges Ahead on Energy Transition’s Inflation Significance; Lane Plays it Safe
10 January 2022
By David Barwick – FRANKFURT (Econostream) – For anyone interested in how the energy transition might ultimately play out in terms of inflation, European Central Bank Executive Board member Isabel Schnabel provided the clearest theoretical answer to date.
In a speech on Saturday likely to have made monetary policy doves wince, Schnabel showed little to none of the ‘wait-and-see’ hesitance ECB Governing Council members have generally exhibited about delving into a complex topic with opposing aspects, and was equally unshy about drawing policy conclusions.
‘Monetary policy … cannot afford to look through energy price increases if they pose a risk to medium-term price stability’, she declared.
‘This could be the case if prospects of persistently rising energy prices contribute to a de-anchoring 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.’
Though couched in terms of coulds and ifs, Schnabel did not shy away from delivering arguments in support of the idea that the energy transition constituted a primarily upside risk to price stability.
For example, she elaborated, consumers’ expectations are driven to a large extent by price changes of items bought relatively often, such as energy, with the price of a key component of that index being readily observable at any petrol station. In 2021, consumer price expectations tracked energy, she suggested.
Naturally, Schnabel denied any indications that a wage-price spiral had taken hold, while identifying an elevated risk of this associated with the energy transition.
Similarly, she dispensed with the sometimes-heard assertion that the energy transition’s net impact on prices could be negative as activity slowed in response to higher input prices. A carbon tax is not the sort of adverse shock that might on such a basis justify disregarding the price increase for monetary policy purposes, she said.
For one thing, the energy transition should ultimately ‘boost, rather than weigh on, economic growth and thereby support wages and aggregate demand’, she reasoned. For another, the effect of the transfer of money from the private to the public sector, implied by a carbon tax, depended on how the revenues were handled, she said.
The outcome could actually be higher economic activity, she said: ‘And since new activity will likely arise in greener sectors, part of the increase in GDP will be permanent, potentially raising inflation both over the short and medium term.’
‘These findings are not just hypothetical’, she added. ‘An 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.’
Schnabel’s speech is an important contribution to a discussion that needed to take place. That she sees the energy transition as more likely a source of upside than downside price risks is not a surprise, but less because she is relatively hawkish in the context of the Executive Board and more because her previous comments on the subject, though less detailed, already gave a clue as to where her thinking was headed.
‘Eventually if we are serious about fighting climate change the green transition will need to bring about a measurable further rise in the price of carbon which can be expected to lead to higher fuel and electricity prices’, she said in a speech two months ago, for example. ‘These effects may become entrenched in expectations if people start to anticipate them.’
The ECB has already taken its sweet time about waking up to the possibility of higher-for-longer inflation and has had to adjust its rhetoric with a haste bordering on unseemly.
While the EU’s carbon border tax won’t be fully implemented for another four years, importers will have to comply with significant administrative requirements as of one year from now. The ‘eventually’ of Schnabel’s November speech is thus arguably already overlapping with the ECB’s forecast horizon, and there is little excuse for monetary authorities to be blindsided again.
Inasmuch, it might be hoped that Saturday’s intervention will be received as a wake-up call to anyone setting European monetary policy who plans to cross that particular bridge only upon coming to it.
In contrast to Schnabel’s speech, Philip Lane took care not to wade into any controversy with his latest public intervention.
Published Friday by Irish national broadcaster RTÉ and devoted almost exclusively to inflation, it may never have been intended to be much more than the honouring of a commitment to a hometown news outlet with no particular interest in monetary policy.
Still, given Lane’s most recent previous public remarks were two months ago, one might have anticipated a more standout observation from the ECB chief economist than that inflation in 2023 and 2024 was likelier to come in below the price stability target than above it. In other words, that the Eurosystem HICP projections released on December 16 remain valid, as one would expect.
To be sure, Lane quickly noted that the ECB would benefit from ‘new forecasts in March, in June, in September’ and be guided by these. Still, he did not appear to be undermining the newest forecasts, in contrast to the speed with which monetary authorities had distanced themselves from last September’s.
Also of possible interest was Lane’s preoccupation with energy’s role in inflation past, current and future, to the complete exclusion of the supply chain bottlenecks that featured prominently in his exposition of inflation just a few weeks ago.
But all in all, one might almost just as well have simply reread Lane’s previous interview, published on November 8, in which he also said that inflation would fall this year; that medium-term price prospects were subdued relative to the ECB’s target; that the transient nature of current high HICP argued against a policy overreaction; and that the ECB was watching to see if elevated inflation was generating unsustainable new behaviours but saw no evidence of this yet.