The head of the European Central Bank said inflation has become more unpredictable due to shocks like the COVID-19 pandemic and Russia’s invasion of Ukraine — and that policymakers need to take the possibility of such extreme scenarios into account and communicate them to the public as well.
“The world ahead is more uncertain, and that uncertainty is likely to make inflation more volatile,” ECB President Christine Lagarde said Monday in a speech opening the central bank’s annual conference in Sintra, Portugal. “It’s pretty basic but that’s the reality.”
One reason, she said, was that increasingly regular supply disruptions were leading companies to change their prices more frequently, a habit that goes beyond the recent burst of inflation in the U.S. And Europe and “reflects a structural shift in how firms operate under conditions of permanently higher uncertainty.”
The bank’s assessment of the economy needs to rely on taking extreme possible scenarios into account as well as the more likely baseline predictions, and it should let the public in on those possible outcomes as well, she said. Lagarde in particular cited the inflation spike that followed Russia’s invasion of Ukraine, where a baseline scenario based on higher energy prices suggest inflation for 2022 of 5.5% – but a worst-case scenario indicated more than 7% inflation, much closer to the final figure of 8%.
Another example was the pandemic, where spending by homebound consumers shifted from services like restaurants to goods such as home exercise equipment.
“Scenario analysis could have helped in illustrating that the range of possible inflation outcomes was unusually wide – and would have reduced the risk of projecting false certainty to the public,” Lagarde said.
The bank’s strategy review announced Monday reaffirmed its target of 2% for inflation, a goal it has met for the time being as annual price increases were 1.9% in May. The drop in inflation has let the bank cut its benchmark interest rate from a peak of 4% to 2%.
Threats of higher tariffs from U.S. President Donald Trump have added to uncertainty about the outlook for growth and inflation. The European Commission and US negotiators are trying to reach agreement on a trade deal ahead of a July 9 deadline.
The conference in Sintra is the ECB’s equivalent of the U.S. Federal Reserve gathering in Jackson Hole, Wyoming, and gathers top central bankers and economists from around the world. Fed Chair Jerome Powell is to take part in a panel on Tuesday with Lagarde, Bank of England Government Andrew Bailey, Bank of Korea Governor Chang Yong Rhee and Kazuo Ueda, the governor of the Bank of Japan.
