ECB Insight: Panetta Still No Fan of Normalisation, But No Longer Quite as Bent on Thwarting It

6 April 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Fabio Panetta on Wednesday recited his most current litany of reasons why monetary policy tightening shouldn’t be necessary, but his opposition seemed to have weakened and his previous downplaying of high inflation to have given way to a less categorical view.

In a lecture he gave on being awarded an honorary law degree by the University of Cassino and Southern Lazio, Panetta argued that high inflation was imported rather than driven by high domestic demand. As such, he said, monetary policy could do little about it anyway without ‘considerably lowering real activity and employment, knocking down wages and income.’

Is however anyone seriously, in Panetta’s words, ‘asking monetary policy alone to bring down short-term inflation’? Monetary policy being universally regarded as incapable of operating on short-term price developments, we think he may be resorting here to a bit of a straw man argument.

On the other hand, it cannot be denied that policymakers have become unusually sensitive to short-term developments, in marked contrast to the ECB’s historic tendency to resolutely look through certainly monthly and even quarterly inflation developments.

The problem this is a reaction to is that repeated individual HICP outcomes that not only top projections but are also far in excess of the ECB’s 2% target are seen as chipping away at economic agents’ confidence in a generally stable price environment. For each worker about to make wage demands and each merchant considering what prices to charge, any single reading could be the proverbial last straw.

Panetta, understandably, prefers the more favourable ground of the medium term in which, formally speaking on the basis of current staff projections, all is still reasonably well and he can thus, at limited cost, appear to be as ardent a defender of price stability as the next central banker. ‘Monetary policy will play its role, adjusting policy in line with the medium-term inflation outlook’, he said.

But, leaving little to chance, he doesn’t allow the impression to arise that he sees much need to act on this basis, declaring there to be no evidence of second-round effects and adding that ‘they may not materialise given the credibility of our commitment to preserve price stability, which helps anchor inflation expectations, and the exceptional degree of uncertainty we face today, which may induce workers to prioritise job security over wages rises.’

There is a certain irony in it being precisely Panetta, at the dovish extreme of the spectrum, expressing confidence that the presumably widespread perception of the ECB as rock-solid guarantor of stable prices will be enough to nip second-round effects in the bud.

By some accounts, expectations are already rising beyond what has to now been deemed a ‘recovery’ to levels consistent with the ECB’s objective. For example, according to Austrian National Bank Governor Robert Holzmann last week, ‘there are first signals there on the market measured that … the inflation expectations may [be] moving upwards.’

And ECB Executive Board member Isabel Schnabel on March 17 said that the ECB was ‘carefully monitoring the recent rise in long-term market-based measures of inflation compensation to levels above 2%.’

That European central bankers exhibit what one insider in conversation with Econostream called ‘different understandings’ of inflation expectations partly reflects national origin – Italy in Panetta’s case, Austrian in Holzmann’s, German in Schnabel’s – and the influence this has on mindset.

But for all his scepticism about policy normalisation, Panetta’s opposition has lost some of its resolve, and today he eventually acknowledged that ‘uncertainty continues to require careful and gradual steps in adjusting policy.’

That doesn’t sound all that much different from his last monetary policy comments at the end of February, when he admitted that ‘there is a case for the central bank to accompany the recovery with a light touch, taking moderate and careful steps in adjusting policy’.

But at that time, Panetta was worried that ‘[i]n such a finely balanced situation, any errant policy measure could easily push the economy onto the wrong path and put at risk what we have achieved so far’ and wanted ‘to see more evidence … to be confident that the low-inflation scenario has fully disappeared.’

Fears of erring on the wrong side were absent today, and even Panetta seemed more concerned about inflation. ‘Oil and gas prices will stay higher for longer and remain subject to unprecedented uncertainty’, he said.

Having established himself so firmly in the dovish camp, Panetta has not made life easy for himself at a time like the present; a complete about-face would be at the cost of all credibility. It is more a question of piecemeal concessions to reality, and we think today’s speech was an example of this.