ECB Should ‘Err on the Side of Doing Too Much Rather Than Too Little’, Schnabel Says

19 June 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – The European Central Bank should favour doing too much rather than too little in the battle against inflation, ECB Executive Board member Isabel Schnabel said on Monday.

In a speech at a Euro50 Group conference in Luxembourg, she said that risks to the Eurozone inflation outlook were tilted to the upside.

The ECB needed to ‘remain highly data-dependent and err on the side of doing too much rather than too little’, she said. This was because underestimating inflation persistence, as she conceded the ECB had done recently, could lead to costly policy mistakes, and relying solely on projections was inadequate in uncertain times.

The risks to the inflation outlook were ‘tilted to the upside, reflecting both supply- and demand-side factors’, she said.

‘Risks of both a de-anchoring of inflation expectations and weaker monetary policy transmission suggest that there is a limit to how long inflation can stay above our 2% target’, she said.

The ECB therefore needed ‘to keep raising interest rates until we see convincing evidence that developments in underlying inflation are consistent with a return of headline inflation to our 2% medium-term target in a sustained and timely manner', she said.

She highlighted the ‘exceptionally strong’ euro area labour market, with ‘continued employment growth’ expected in the coming months. Labour market developments meant that ‘one of the key channels in policy transmission – if not the most important one – is currently not working as usual’, she said.

Structural factors, ‘such as the rise in sick leave, the higher share of services in value added and a shortage of workers’, were contributing to this, along with high demand, she said.

The shift towards services was also ‘likely to affect monetary policy transmission’, she said, because ‘services are less capital-intensive and their prices are, on average, more rigid than in other sectors, changes in interest rates are slower to affect aggregate inflation outcomes.’

Negative supply shocks and a persistent weakening of Eurozone supply capacity were examples of further upside risks to the inflation outlook, she indicated.

Monetary policy also needed to ‘become more restrictive’ due to the fact that government support measures introduced during the pandemic were being reversed too slowly and therefore fiscal policy was still too accommodative, she said.