Scant Evidence of Excess Demand Driving Eurozone Inflation, Visco Says

25 April 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – European Central Bank Governing Council member Ignazio Visco said on Tuesday that excess demand was not a key driver of inflation in the euro area, despite the unexpected strength of the economy.

In a paper published by the Centre for Economic Policy Research, Visco, who heads the Bank of Italy, said that the ECB should be prudent given the large amount of hikes already in the pipeline, which have yet to take full effect on the real economy.

The resilience of the Eurozone economy was leading to ‘a certain degree of overemphasising, including in policy debates, the role of demand factors as drivers of the current inflation cycle', he said. Overall there was ‘still scant evidence of excess demand’ in the euro area, he said.

The effects of supply shocks in the euro area ‘continue to be the main driver of both headline and core inflation’, he said.

‘[M]ost of the economic impact of the rate hikes that have been implemented so far is yet to be felt’, he said. This meant ‘that a degree of prudence is warranted, as their full results are about to be seen.’

He said that ‘data on market- and survey-based inflation expectations – including their recent decline at short horizons and their decreasing profile – call into question the persistence of inflation at high levels in the euro area, reinforcing the arguments in favour of gradual monetary tightening.’

The ‘effectiveness of the monetary tightening’ was ‘evident’ in his view, considering ‘the marked increase in financing costs for households and firms as well as the sharp deceleration in money and credit.’

The falling numbers of loans to firms, the deceleration of growth in credit to households, and the fact that the dynamics of M1 and M3 were ‘in deeply negative territory and at unprecedented lows’ suggested ‘that monetary policy has already started to exert its impact’, he said. In the absence of further shocks, ‘the progressive unfolding of its lagged effects’ would ‘further contribute to bringing inflation back in line with the medium-term definition of price stability.’

He said that the evolution of inflation expectations showed ‘signs of the effectiveness of the Governing Council’s actions’.

A wage-price spiral was ‘not discernible’ at the current moment in the Eurozone, he said. Despite ‘increasing wage trends’ being ‘somewhat more accentuated’, there were ‘no clear signs’ of a wage-price spiral, which had so far been ‘averted’.

High core inflation ‘could last for some time’, he said, with the ‘historically high persistence of price dynamics’ in the sectors driving core inflation suggesting ‘that the future decline of core inflation may be rather gradual’.

Financial stability risks were ‘not negligible’ and required ‘a good dose of caution’, he said. He warned that the ‘unprecedented and simultaneous hikes of official rates in many countries could create unexpected spillover effects that, although difficult to quantify, may not be insignificant.’

He repeated that the ECB should ‘strike the right balance between the risk of a too-gradual recalibration, […] and that of an excessive tightening’, saying that ‘equal weight should be given to both risks.’