Members of the European Central Bank (ECB) will raise key rates again when they meet on 8 September. The only unknown is the size. 75 basis points instead of 50 seems to be a consensus. An option all the more justified given that the inflation figure for August, 9.1% over one year, is accelerating compared to the 8.9 in July.
“Today, high inflation has become the main concern of citizens in many countries”noted Isabel Schnabel, an influential member of the European Central Bank (ECB) Executive Board, at the Jackson Hole Symposium on August 27, the annual mass of central bankers, where she represented the European monetary institution. “Central banks must react strongly. They must take seriously the risk of people starting to doubt the long-term stability of our fiat currencies. “he warned, in a remarked speech, entitled “Monetary policy and great volatility”.
“To regain and maintain confidence, we need to get inflation back to target quickly. The longer inflation remains high, the greater the risk that the public will lose confidence in our determination and our ability to preserve our purchasing power.he has declared.
However, this priority return to the 2% target, the target rate of the ECB and the Fed, is not easy to achieve. The pandemic and the war in Ukraine have opened a period of high volatility in which supply shocks drive up prices and reduce production. The “Great Moderation”, this period that began in the late 1980s and characterized by low price volatility, stable production and economic expansion that allowed for decades to significantly improve the living conditions of the inhabitants in most countries, has disappeared. . “The volatility of output growth in the euro area over the past two years has been about five times higher than in the 2009 recession. The volatility of inflation has exceeded the levels recorded in 1970”observes Isabel Schnabel.
The price increase was underestimated in 2021
Also, to avoid entering a period of “Great volatility”monetary policy tightening is needed “Even at the risk of weak growth and higher unemployment”, consider this seasoned economist. Judging, in the form of self-criticism, that the persistence of the price hike since 2021 has been underestimated, today recommends decisive actions to avoid much more harmful costs in the long run, recalling that price stability is a condition for having a strong currency too, which is a guarantee of trust for families whose purchasing power is preserved.
“Trust in our institutions has become even more important at a time of major and disruptive structural changes that result in larger, more persistent and more frequent shocks. A reliable nominal anchor facilitates the transition to the new equilibrium and improves the arbitration that central banks will face in the future.
When shocks are large and frequent, central banks can no longer give any reliable signals on the future evolution of short-term interest rates. Monetary policy therefore needs to be tightened due to “uncertainty about the persistence of inflation, the risk of a loss of central bank credibility and the potential costs of acting late”, she sums it up.
A less favorable general environment
Indeed, even when the exceptional consequences caused by the pandemic and the war in Ukraine have subsided – which is difficult to predict – governments and central banks will find themselves in a less favorable and very different general context from that which prevailed in the early 2000s, or even after the 2008 financial crisis, when the coordination of countercyclical policies and the concerted action of central banks had allowed them to emerge more rapidly.
Therefore, today, climate change is forcing all countries to adapt. “The incidence and severity of extreme and disruptive weather events expose the global economy to greater volatility of production and inflation”, Isabel Schnabel points out. This summer, Europe, like many other regions of the world, suffered from one of the worst droughts ever recorded, with nearly two-thirds of its territory on alert or alert. In recent weeks, torrential rains in Pakistan have been turning into human, social and economic disasters.
The questioning of globalization also contributes to this growing volatility. Already undermined by Donald Trump’s protectionist program during his presidency, the globalization of trade and the integration of a large part of the population of emerging countries into the world labor market have significantly increased production capacities allowing to absorb demand shocks and contain rising prices and wages.
Since 2020, the pandemic and the war in Ukraine have heightened this risk of fracturing the world economy into competing blocs of trade and security, particularly between emerging and developed economies, a division reinforced by Western economic sanctions imposed on Russia.
Covid-19: one third of the world population is not yet vaccinated
Isabel Schnabel cites two examples of the withdrawal of multilateralism. Although Covid-19 vaccines have been around for nearly two years, a third of the world’s population has not yet received an injection. However, this unequal treatment prevents the end of the Covid-19 pandemic. Similarly, the invasion of Ukraine by Russia, two major grain producers, has reduced the world supply of wheat. However, many governments have decided to take measures to limit the export of food products rather than international cooperation.
This food protectionism is causing severe social unrest in many of the poorest countries. Similarly, during the pandemic and the reboot of the global economy, bottlenecks in supply chains not only disrupted production, as in the case of semiconductors, but questioned the issue of sovereignty strategy at the top of the agenda. of de-globalization. However, transfers made to benefit from stronger value chains can also create duplication and generate inefficiency. Not to mention that national dependence too great “It can make countries more – rather than less – vulnerable to future shocks”remembers Isabel Schnabel.
A less elastic energy supply
Another stabilizing factor that has disappeared: the elasticity of the energy supply. Unlike in the 1970s, when the world’s oil supply depended heavily on OPEC, the arrival of production from Mexico, Norway and other countries reduced the cartel’s influence to less than 30% in the 1980s. . The United States, which had become the world’s largest oil producer, also significantly increased the price elasticity of the oil and gas supply, as the nuclear programs of countries such as France or Japan had previously achieved. electricity. Today, the OPEC + partnership, which brings together OPEC and a dozen other exporting countries, including Russia, has regained influence on the oil market.
Although the energy transition has become a priority since the COP in Paris, Europe is preparing to ration electricity and gas this winter, a situation unimaginable just a year ago. Indeed, the war in Ukraine showed the extreme dependence of developed economies on fossil fuels. Until renewable energies are true alternatives, gas and oil prices will remain consistently high.
But the energy transition itself is inflationary in nature. The supply of metals such as copper, lithium and cobalt necessary for the electrification of the economy is limited in the short and medium term, especially as their production is also concentrated in a small number of countries. The world economy will therefore shift from a dependence on fossil fuels to that of metals, potentially generating high price volatility due to competition between companies and governments to secure supplies.
Priority to social cohesion and investment in decarbonisation
For these reasons, and if they want to reduce volatility in the medium term, governments must adopt their fiscal policy in a prolonged period of weak economic growth. With the debt-to-GDP ratio reaching historic highs, public spending must be dedicated as a priority, according to Isabel Schnabel, to social cohesion and investments in the decarbonisation of the economy, which offer opportunities for new production and jobs, which they will result in long-term economic prosperity.
As for central banks, their credibility is at stake. “In the eurozone, consumer medium-term inflation expectations remained firmly anchored to our 2% target throughout the pandemic. According to the most recent data, median expectations are around 3%, while average expectations have increased from 3% a year ago to almost 5% today “Note.
This new perception could instill in people’s minds not only that monetary authorities have reacted too slowly to rising inflation, but that they are unwilling to commit to price stability. In addition, there is the potential high cost of late and abrupt intervention, which brings back the hyperinflationary spectrum of the 1970s, and shock therapy from Fed chief Paul Volcker, which raised rates by up to 20%.
Such a shock cannot be excluded due to the change in the economic structure in recent decades, where the share of intangible capital has tripled since 1980. In the euro area it has risen from 12% in 1995 to 23% today. However, intangible capital is more difficult to mobilize as collateral for bank loans, which lowers the cost of credit and services are less responsive to monetary policy than more capital-intensive sectors, such as manufacturing.
Finally, Isabel Schnabel’s arguments in favor of a monetary policy that would make her classify as a “hawk” at the ECB, are reminiscent of a Pascalian bet where, despite the large number of uncertainties, the choice to act presents less risk. compared to the status quo, or at least a conservative approach. “An important lesson from the Great Moderation is that it is also up to central banks to know whether the challenges we face today will lead to Great Volatility, or whether the pandemic and war in Ukraine will ultimately be remembered as painful but temporary interruptions of the Great Moderation”, Isabel Schnabel warned at the end of her speech. Member of the ECB Executive Board, you clearly made your choice.