Speeches
Statements by Yannis Stournaras, Governor, Bank of Greece
Governors' panel "Inflation: Can Central Banks Cope?", European
Forum Alpbach (EFA) 2022
30/08/2022 - Speeches
Drivers of inflation
Let me first say that it is a pleasure and an honor to be participating at the European Forum Alpbach.
Upon its founding in 1945, the Forum was one of the first post-war initiatives that aimed to establish a
unified and democratic European community.
We have come a long way since that time but, as the war in Ukraine has shown, we are still some
distance away from achieving the goals of Otto Molden and Simon Moser, the founders of this
wonderful forum.
Robert Holzmann has posed a very important question: what are the drivers of the very high inflation
rates that we see today?
It has been over a year since the euro area economy has been hit by a sequence of supply shocks --
including successive waves of the pandemic-- that have pushed up inflation.
We have seen a spike in fuel prices and a series of supply disruptions caused by the pandemic, which
raised energy and commodity prices further.
While the euro area economy was just recovering from the pandemic earlier this year, it was hit by
another major shock stemming from the outbreak of the war in Ukraine and the associated sanctions.
The shock exacerbated the supply bottlenecks and intensified the surge in energy, commodity and
food prices.
These surges in energy prices have hit the euro area much harder than they hit the Unites States, which
is not nearly as dependent on imported energy.
In parallel, as restrictions imposed to curb the pandemic waves were lifted, pent-up demand, especially
in the services sector, strengthened and, as a result, upside pressures on prices broadened and
intensified.
If all this was not enough, in the years 2020 and 2021 the U.S. government undertook fiscal expansions
amounting to 20 per cent of that country's GDP - an unprecedented amount in peacetime.
These fiscal expansions played a role in feeding the rise in inflation in the United States. With almost 50
per cent of global trade denominated in U.S. dollars, there were spillover effects to other countries.
To contain the domestic inflationary impact, the Fed has aggressively raised its policy rate, thus
contributing to currency depreciations against the dollar, including of the euro, which added to
inflationary pressures in the euro area.
To sum up, we have been hit with a perfect inflation storm.
What, then, is my prognosis about inflation?
The answer is not simple. In dealing with inflation, we are dealing with what the ancient Greeks called
the Hydra multi-headed monster.
It is difficult to tame inflation, because the inflation process, like that monster, is complex, reflecting
multiple shocks hitting the economy.
As Fed Chair, Jerome Powell, recently stated "we now understand better how little we understand
about inflation."
I believe that the succession of ever-increasing inflation numbers is shortly coming to an end. A steady
deceleration is about to begin.
Among other things, my view is based on an assumed moderation in energy and commodity price
increases and a gradual easing of the supply bottlenecks.
According to our latest projections at the ECB (published in June), inflation is expected to peak before
year-end, to gradually decline in 2023 and converge towards target in 2024. A similar profile is
expected for core inflation.
This inflation profile is mirrored in measures of expected inflation.
Market-based inflation expectations (measured by the 5 year/ 5 year forward inflation-linked swap
rate) continue to be well-anchored -- fluctuating slightly above and slightly below 2 per cent for a
considerable period.
Recent survey measures of longer-term inflation expectations (such as the ECB survey of professional
forecasters and survey of monetary analysts) remain close to 2 per cent. Similar forecasts have been
released by other economic institutions.
Some factors which help explain the sluggish reaction of expectations are the following.
Available data on wage growth provide evidence of still moderate pass-through from rising prices.
The Russian invasion of Ukraine has put a strain in output growth and has worsened confidence and
economic sentiment, adversely impacting investment and consumer spending.
Elevated prices are reducing the real disposable income of households, with negative implications on
savings and consumption. The fall in stock prices on the past several months suggests that financial
wealth has eroded.
Risks to euro-area, as well as global, growth are increasingly tilted to the downside. This could mean
lower pressures on prices over the medium-term.
Against this backdrop, monetary policy faces the dilemma of bringing inflation down to target, while
ensuring a soft-landing amid rising fears about economic recession.
Instruments & challenges to cope with inflation
What has made the inflation storm especially difficult for monetary policy makers in Europe, is that a
perfect policy reaction is not possible.
The argument that monetary policy should be tightened when inflation rises hinges on inflation being
demand driven.
That argument may be partly true for the United States, but it clashes with the European reality. In the
euro area, inflation has been driven by the supply side.
When inflation is driven by supply-side pressures, an undue tightening of monetary policy would
aggravate the negative output effects of the supply side shocks.
Accordingly, the main challenge is to bring down inflation, while not triggering a sharp decline in output
and employment.
In this environment, the appropriate monetary policy response has in my view been to ride out the
succession of supply-side shocks, proceeding with policy normalization in a gradual but determined
manner, incorporating optionality and flexibility.
I believe that our approach of gradual normalization has been successful and should continue.
In December last year when we embarked on this process, up to June this year, we took a series of
decisions in this direction. We have ended net purchases under our two asset programs, removed the
easing bias of our forward guidance, did not prolong the very favourable terms - of a rate that could
go down to minus 1 per cent - on targeted longer term refinancing operations, and have been phasing
out collateral easing measures.
In a historic move in July, which marked the end of the eight-year-long era of negative rates in the euro
area, with my colleagues on the panel today and the rest of the Governing Council we decided to raise
our key policy rates by 50 basis points.
The hike was larger than what was signaled on the occasion of our June monetary policy meeting,
reflecting our assessment that a materialization of risks to the inflation outlook had, in the meantime,
taken place since the June meeting.
These risks not only relate to the rise in inflation to very high levels but also to increases in indicators of
underlying inflation, which pointed to the need for a re-optimisation of our policy stance.
In the forthcoming meetings, a further progressive normalisation of policy rates will be appropriate in
order to converge to the estimated equilibrium interest rates, as we transition to a meeting-by-meeting
approach.
Both the timing and the pace of moves will depend on the evolution of our assessment with respect to
inflation risks. Supply-side and war-related disruptions may persist. But slowing demand will act to
reduce inflation. The Governing Council will need to remain attentive to all factors. A gradual or a step-
by-step approach is appropriate given the surrounding high uncertainty and the supply-side nature of
inflation.
Let me now turn to a very important pledge we have made at the Governing Council, ever since we first
embarked on the gradual process of policy normalization: any resurgent fragmentation risks that
would undermine the smooth transmission of the normalisation of our monetary policy across all
countries in the euro area must be forcefully confronted.
This summer, the Governing Council acted forcefully on this pledge.
In June, it applied flexibility in reinvesting redemptions coming due under the Pandemic Emergency
Purchase Programme (PEPP), with a view to maintain the functioning of the monetary policy
transmission mechanism.
This is a first line of defense to counter risks to the transmission mechanism related to the pandemic.
In July, the Governing Council introduced the Transmission Protection Instrument (TPI). The TPI is a very
powerful tool that will support the effective transmission of the ECB's single monetary policy across all
countries of the euro area as monetary policy is normalised.
The euro area has been at the epicenter of strong and successive fragmentation episodes. A major
reason for that is in my view that our monetary union is incomplete. In the absence of a complete
banking, capital markets and fiscal union, we would have faced a distinct possibility of further
fragmentation episodes in the future if we had not adopted the TPI.
To conclude, we remain determined at the Governing Council, to eradicate the Hydra-headed monster
of high inflation, without leaving unattended risks to the transmission of our single monetary policy, to
financial stability and to economic activity.
Short concluding remarks
Let me conclude with the following remarks.
Monetary policy can be a powerful tool to maintain price stability if the shocks hitting the economy are
from the demand side.
During the past few years, the euro area has been hit by a series of shocks. The Governing Council has
determined that the shocks, especially for the euro area, have predominantly come from the supply
side of the economy. Like the Hydra monster, these supply-side shocks have been multi-headed.
We have navigated the rough seas of high inflation with the needle of our compass on our medium-
term objective - an inflation rate of 2 per cent.
To help us navigate these rough seas, we have kept a close eye on inflation expectations. Throughout
the storm, inflation expectations have remained close to our 2 per cent objective.
We have formulated policy in such a way that will minimize the output and employment costs of
bringing down inflation using a policy framework entailing gradualism and flexibility.
We remain determined to eradicate the Hydra-headed monster of high inflation, without leaving
unattended risks to the transmission of our single monetary policy, to financial stability and to
economic activity.
We have therefore developed an important new tool, the TPI, which will allow us to both respond to
inflation aggressively and to thwart any threat of fragmentation.
I am confident that, by the end of 2024, the inflation monster will have been defeated.