ECB’s Panetta: Outlook Consistent with Reducing Accommodation, But Must Be Prudent About How Much
14 November 2022
By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Fabio Panetta on Monday said that monetary policy had to proceed carefully, lest too much tightening caused a permanent output decline, but accepted the need to withdraw accommodation and did not exclude moving into restrictive territory.
In a speech at a conference in Florence, Italy, Panetta said that ‘monetary policy has to ward off the risk of a de-anchoring of inflation expectations, which could lead to second-round effects in the form of excessive wage and price-setting dynamics. That implies adjusting monetary conditions and frontloading rate hikes.’
The risks associated with currently elevated inflation ‘should not be underestimated’, he said.
‘But so long as expectations remain anchored, the calibration of our policy adjustment should take into account the unprecedented uncertainty of the post-pandemic world’, he said. The assumption that potential output has lastingly decreased due to supply shocks could mislead monetary policymakers into tightening excessively, he said.
‘If not corrected quickly, this could result in a permanent loss of output as productive capacity adjusts to significantly and persistently lower demand’, he said. ‘And that scar may prove difficult to heal.’
Prudence doesn’t imply that there will be no need for monetary policy to become restrictive, he said. ‘But in the absence of clear second-round effects, we would need convincing evidence that the current shocks are likely to keep having a more adverse effect on supply than on demand’, he said.
Panetta said there were ‘limits’ to the argument that the costs of underreacting to inflation were greater than those of overreacting.
With the ECB already having implemented 200bp of tightening, it would be inadvisable to be aggressive, given uncertainty as to whether potential output was lastingly lower, he said. Rather, ‘current macroeconomic policies should be designed to avoid unnecessarily heightening the risk that the increasingly likely contraction in coming months becomes a severe and protracted one, which would scar the economy’, he said.
In addition to putting demands on energy and fiscal policies, this imperative ‘also requires that monetary policy does not ignore the risks of overtightening’, he said.
Even if potential output were seen as lastingly reduced, the meaning would require analysis before being reflected in monetary policy, he said, since, for example, the loss may be accepted by workers to a degree or households may cut spending.
The significance for monetary policy can thus ‘only be derived over time’, he said. ‘And this reinforces the case that, for as long as inflation expectations remain anchored, monetary policy should adjust but not overreact.’
The latest staff forecasts ‘are consistent with a withdrawal of monetary policy accommodation’, he said. ‘But the uncertainty surrounding supply and demand dynamics requires us to remain prudent as regards how far the adjustment needs to go.’
Panetta observed that previous decisions and the expectations of additional policy moves had yet to exert their full impact. ‘Estimates suggest that this tightening will on average subtract more than one percentage point from annual real GDP growth each year until 2024 compared to a counterfactual where interest rates and balance sheet expectations would have remained unchanged since December 2021’, he said.
Policy should be based on ‘comprehensive analysis of the data’, he said, since ‘selective anecdotal evidence is certainly not a better guide.’
Supply-side elements would be key to inflation developments ahead, he said, noting ‘the lagged effect of previous bottlenecks and the staggered pass-through of wholesale energy costs into retail bills.’