ECB’s Schnabel: Greater Financial Literacy Supports More Effective Monetary Policy Transmission

27 March 2025

By David Barwick – LONDON (Econostream) – European Central Bank Executive Board member Isabel Schnabel on Thursday said that higher levels of financial literacy were conducive to monetary policy transmission.

In a lecture at the Bayes Business School, Schnabel, who confined her formal remarks to the topic of financial literacy, endorsed efforts by central banks to make populations more financially literate, arguing that this ‘can make monetary policy more effective in achieving its objectives and lower the sacrifice ratio – that is, the cost of reducing inflation in terms of lost output or higher unemployment.’

Moreover, she said, supporting financial literacy could improve people’s trust in their monetary authorities, thereby aiding other policy objectives such as a more financially unified Europe.

The validity of common economic models in which monetary policy operates via interest rates could be undermined by financial literacy deficits, because these could lead economic agents to act at odds with the models’ predictions, she said.

‘Consequently, policymakers may make mistakes in predicting household behaviour, affecting the way monetary policy is transmitted to the real economy’, she said.

The dependability of the risk-taking channel through which monetary policy also works could similarly be compromised by poor financial literacy, she said.

For example, financial literacy promoted investment in stocks and mutual funds and was also positively associated with demand for mortgages and other loans, all of which supported the transmission mechanism, she said.

Inflation expectations were a third monetary policy transmission channel for which financial literacy was important, she said.

‘Since consumption and investment decisions as well as price- and wage-setting processes reflect expectations about the future pace of price changes, household inflation expectations shape inflation dynamics’, she said. ‘A growing body of research suggests that consumers’ expectations matter greatly for the transmission of monetary policy, possibly more than those of financial market participants.’

According to Schnabel, financial literacy and awareness of the ECB went hand in hand, which in turn had implications for monetary policy credibility.

‘In the most recent inflationary episode, the share of households with high financial literacy that trusted the ECB to maintain price stability over the next three years rose notably after the ECB had embarked on its hiking cycle and inflation had come down significantly’, she said.

Households with low financial literacy were relatively quick to lose confidence in the ECB with higher interest rates, she said.

‘Even when inflation had already come down significantly, the share of households that trusted the ECB’s ability to maintain price stability remained low’, she said, citing evidence from the US showing a majority of the population to hold the view that high interest rates were causally related to high inflation.

‘Therefore, to maintain and improve their credibility, central banks should help people understand their policy actions and their economic effects through communication and enhance their efforts to improve financial literacy’, she said.

The ECB was doing this in various ways, she said, but the effort had to be flanked with other efforts from government and educational institutions.