ECB’s Makhlouf: If Inflation Trends Persist, Case for Action Strengthens, But Caution Needed

10 February 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Gabriel Makhlouf on Thursday said that if the nature of inflation developments did not change, that would argue for monetary policy to react.

In a blog post on the website of the Central Bank of Ireland, which he heads, Makhlouf added however that authorities needed to keep in mind the short-term negative consequences on the economy of a rate hike.

Monetary policy ‘is not an effective tool to deal with supply side drivers, or to address the distributional effects of inflation’, he said. ‘If current trends in overall inflation persist, the case for monetary policy action becomes stronger.’

‘But we need to be conscious of the effects of tightening policy: constraining demand now to bring it back into line with supply would impact on inflation with a lag but there would be a more immediate trade-off in terms of growth and employment’, he added.

Uncertainties were mounting, he said. ‘Some will have a shorter-term impact on inflation, whereas others could prove to be more long-lasting’, he said. ‘It will be important to remain data-driven in our assessment of the evolving inflation outlook and ready to take policy actions to ensure that inflation stabilises at our 2% target over the medium term.’

Makhlouf, who characterised economic prospects as positive, said that the source of inflation was an important aspect, and that ‘[s]trong increases in energy prices mean that the leading driver of current inflation has been from the supply side but monetary policy’s primary effect is through the demand side of the economy.’

‘[C]onstraining demand to bring it back into line with what might be a temporary supply interruption could depress incentives for supply to return and therefore be counterproductive’, he said. ‘But we have also seen evidence of more broad-based price changes, beyond just energy prices.’

Core inflation was an important indicator and at 2.3% last month versus 1.6% six months earlier, he said. ‘While our current expectation is for both headline and core inflation to fall over the current projection horizon (to end-2024), we pay close attention to developments in core inflation to help us form a view on inflation dynamics over the medium term’, he wrote.

Labour market developments were ‘central’ with respect to whether inflation or declining unemployment affect wage demands and eventually prices, he said. In Europe, ‘we have yet to see strong evidence of this in the euro area (notwithstanding that our wage data comes with a long lag)’, he said. ‘Overall, I think it is fair to say that the risks to inflation- from many sources- are to the upside in the near term.’