#EconomicPolicy
#EconomicPolicy76
High Inflation in the Eurozone
New study lays out warning signs for what could go wrong – and the five ways in which the central bank could fail to bring it back to target
Bringing inflation down after it has risen sharply but only recently is relatively easy: raise policy interest rates, quickly, and persist until inflation starts coming down and expectations of future inflation are solidly re-anchored.
But as Professor Ricardo Reis of the London School of Economics explains in a new research report to be published this week, if the European Central Bank (ECB) yields to misjudgment, incredibility, fiscal, financial or recession dominance, it will not follow through with raising rates as high or for as long as necessary. He outlines the five types of dominance and the ways in which they might become obstacles to raising policy rates.
The ECB’s mandate is clear: to deliver price stability. While it can, and should, consider all of these factors, it is instructed to have the control of inflation dominate them all. At the same time, the research notes, if the ECB raises rates too much, for too long (and is slow to cut rates just as sharply as inflation starts coming down), it can break the fiscal budget, the financial system or the real economy. Economic policy always requires a balancing act.
Professor Reis concludes: ‘My study takes a gloomy precautionary perspective of imagining scenarios under which the ECB’s objective of delivering price stability becomes dominated by other factors. In doing so, my hope is that these unwanted dominances are spotted early enough to be stopped – and that inflation comes down on target.’
He will present the new report at the invited policy session of the 76th Economic Policy panel meeting (20-21 October) at the German Federal Ministry of Finance in Berlin. Following the presentation, there will be a panel discussion featuring Agnès Bénassy-Quéré (French Treasury), Olivier Blanchard (MIT and Peterson Institute for International Economics), Wolf Heinrich Reuter (German Federal Ministry of Finance) and Federica Romei (University of Oxford), moderated by Tim Phillips of CEPR.
‘What Can Keep Euro Area Inflation High?’
Author:
Ricardo Reis (London School of Economics)
