The ECB and Its Watchers XXII

March 17, 2022

Steigenberger Frankfurter Hof
Am Kaiserplatz
60311 Frankfurt am Main

The impact of the Ukraine war as well as the significance of climate change and the green transformation on monetary policy were at the forefront of this year's conference The ECB and Its Watchers on March 17th in Frankfurt.

In her speech, the President of the European Central Bank (ECB) Christine Lagarde made it clear that the Governing Council had agreed to respond to a monetary policy guided by optionality, gradualism and flexibility, especially in the face of risks from the Ukraine war. It is prepared to change course if Russia‘s invasion of Ukraine sets in motion "new inflationary tendencies". This flexible approach also includes new instruments. "If necessary, we can design and deploy new instruments to secure monetary policy transmission as we move along the path of policy normalization."

According to Lagarde, the war in Ukraine will lead to higher inflation and weaker economic growth. "We are increasingly confident that inflation dynamics over the medium term will not return to the pattern we saw before the pandemic. But we need to manage a shock that, in the short term, pushes inflation above our target and reduces growth."

The ECB has given itself "extra space" between the planned end of its bond-buying program and the first raise in interest rates in more than a decade, ECB President Lagarde said. "We now say that the adjustment of key ECB interest rates will take place 'some time after' the end of net purchases."

According to ECB chief economist Philip Lane, much of the underlying inflation in the euro area is a factor of high energy prices and will likely fade over time. "But instead of fading back to the pre-pandemic numbers, the projection is that inflation will fade back to the 2% target level," Lane said during the conference‘s first debate with a focus on new challenges in monetary policy.

In February, euro are inflation was 5.9% in February, almost three times the ECB’s target rate of 2%, and the fourth straight month in which the inflation rate hit a record high.

Comparing the impact of the recent global shocks on inflation in the U.S. and the euro area, Stephanie Schmitt-Grohé from Columbia University came to the conclusion that "a slower pace of raising interest rates is not being behind the curve." With inflation in the U.S. hitting a forty-year record high of 7.9% in February, Schmitt-Grohé observes a backlash against inflation in the U.S. "It makes us understand again that low inflation is something that society really values and that central banks have to defend that goal." Ricardo Reis of the London School of Economics warned against a too hesitant approach. In his opinion, there are not various challenges but "essentially one challenge for the ECB that is inflation."

Opening the second panel on climate change, ECB Board Member Isabel Schnabel sees a new age of energy inflation, consisting of "climateflation," "fossilflation," "greenflation." "As the number of natural disasters and severe weather events is rising, so is their impact on economic activity and prices," she said with regard to climate change. "Fossilflation," according to Schnabel, "is to blame for much of the recent strong increase in euro area inflation." Concerning the green transition, Schnabel argued that "as more and more industries switch to low-emission technologies, greenflation can be expected to exert upward pressure on prices of a broad range of products during the transition period." Overall, "monetary policy cannot simply ignore the effects of the green transition if they threaten to jeopardize the achievement of our primary mandate of price stability." At this point, however, she sees fiscal policy "to remain in the driving seat" as "fiscal policy also has an important role to play in buffering the current supply shocks."

In her intervention, Monika Piazzesi of Stanford University pointed out that regarding asset purchases, in the ECB portfolio sectors with high emission overweigh. But "investors are becoming more and more aware that are there is a climate risk." With regard to green monetary policy, Hans Peter Grüner of the University of Mannheim warned against enlarging the scope of the ECB’s activities, comparing the central bank with an octopus. Instead, he called on the ECB to keep it simple, "particularly in times of inflation."

In view of the sharp rise in energy prices, Ignazio Visco, Governor of the Banca d’Italia, brought temporary price controls into play. "The main response cannot come from monetary policy," he said in his opening statement of the third debate on monetary and fiscal interactions. Philippe Martin of Sciences Po, on the other hand, recommended more targeted fiscal transfer, especially to low income households, and emphasized the need for more policy coordination in the euro area. Harris Dellas of the University of Bern advocated a "rethinking of policy practice," arguing that monetary policy had been doing too much. "Central banks need to keep their eyes on the ball," he said, criticizing they were focusing too much on financial stability. In his opinion, central banks need to tighten up aggressively and get fit, normalizing monetary policy to prepare for the next crisis.

Please note that attendance of "The ECB and Its Watchers" conference is by invitation only.

Organization: Prof. Volker Wieland
Media contact: Natascha Lenz