ECB’s Knot: Biggest Job for Monetary Policy in Next Years May Be Keeping High Inflation Under Control

17 March 2022

By David Barwick – FRANKFURT (Econostream) – Keeping inflation from becoming excessive may be the most difficult task for euro area monetary policy in the coming years, European Central Bank Governing Council member Klaas Knot said Thursday.

In the president’s message of the annual report of De Nederlandsche Bank, which he heads, Knot argued that ‘current, long-term unconventional monetary policy is giving rise to more and more risks and undesirable side-effects.’

With the crisis part of the pandemic over and medium-term price stability looking probable, such a policy stance is unwarranted, he said.

‘After years of low inflation, it is conceivable that the greatest challenge in the years ahead will lie precisely in avoiding excessive inflation, given the expected changes in the euro area economy, potentially including greater emphasis on building resilience to future pandemics, the expected expansionary fiscal policy and the climate transition’, he said.

‘These trends may lead to upward pressure on inflation’, he continued. ‘Monetary policy will therefore have to normalise in the years ahead, not least to create sufficient policy scope for dealing with a future crisis.’

Knot noted that amid the high uncertainty surrounding the outlook for energy prices, upside risks stuck out. Russia’s military assault on Ukraine and climate transition measures could both push energy prices up yet further, he said.

In the view of the Dutch central bank, high inflation ‘is due less and less to a number of specific factors, but is increasingly driven by a broad range of goods and services, thus increasing the likelihood that inflation will persist for longer’, he said. ‘The longer the high inflation rate lasts, the greater the risk that this higher level will become anchored in inflation projections and thus in household and corporate behaviour.’

High inflation could induce a wage-price spiral, he cautioned. Such second-round effects were not yet apparent, but can be unpredictable, he said.

‘It is therefore important to closely monitor inflationary developments and the dynamics of inflation projections so that monetary policy can be adjusted in a timely manner if necessary’, he urged.

The ECB’s decision in December to let the pandemic emergency purchase programme run out in March reflects the fact that ‘the crisis phase of the pandemic has come to an end and price stability is more and more likely in the medium term’, he said.