Volker Wieland on the role of central banks and inflation developments in the Fidelity Podcast

"The highest asset of a central bank is its credibility". In the Fidelity Podcast, Prof. Volker Wieland explains what role the credibility of a central bank plays in fighting inflation, what the European Central Bank (ECB) could have done differently in the wake of the Corona crisis, and what factors influence inflation in the long term. He also discusses the differences between the ECB and the U.S. Federal Reserve and explains the so-called Orphanides-Wieland rule.

The ECB doesn't have very much room to maneuver as far as rate hikes are concerned," Wieland warned in an interview with Fidelity capital markets strategist Carsten Roemheld. Demand is still high, he said. However, according to Wieland, the ECB should continue to raise rates even after the recent banking turmoil in early March. "First of all, it's about fighting inflation, and inflation is still very, very high. Even if it comes down a little bit, at 8.5 percent, it's still miles away from the target."

In 2021 and 2022, he said, the ECB hesitated to raise interest rates for too long. "It was underestimated how inflationary the very expansionary fiscal policy, i.e., the many support measures in the Corona crisis, combined with the massive purchase of government bonds by central banks, i.e., the monetization of this debt, can have." According to Wieland, the ECB could have started the interest rate cycle at least six months earlier.

As far as inflation expectations are concerned, Wieland is more pessimistic than current assessments on the financial markets, where an inflation rate close to 2 percent is expected again in 2025. "The real interest rate should already be positive," says Wieland.

In the long term, a phase of higher inflation rates is quite possible, Wieland said, pointing to numerous factors driving prices upward, such as the upheavals in globalization, demographic change and climate policy.

In general, Wieland relies on the use of rules to fight inflation. "A central bank should respond systematically to what is happening in the economy." Together with Athanasios Orphanides, he developed the Orphanides-Wieland rule. This interest rate change rule states that the policy rate should be raised when the forecast interest rate trend is above target and the growth forecast is above potential growth, and vice versa. Together, Orphanides and Wieland applied the interest rate rule to the euro area.

Fidelity Podcast with Prof. Volker Wieland: "Die Rolle der Zentralbanken"