Learn from the past and plan for the future: a
perspective on monetary policy
 Read aloud 
'As the disinflationary path in the euro area continues and the mediumterm
inflation outlook further improves, we become increasingly confident that inflation
will return to target in a timely manner. Consequently, it can soon be appropriate
to ease the currently restrictive monetary policy stance, and gradually take our foot
off the brake.', said Klaas Knot in his speech at the BarclaysCEPR Monetary Policy
Forum today. Knot spoke about the economy, inflation and the outlook for
monetary policy.
Published:  May 
Good afternoon everyone,
Thank you very much for inviting me to join this distinguished panel here at the Barclays
CEPR Monetary Policy Forum. It's a pleasure to be here. I feel particularly inspired knowing
that we are assembled here just a few blocks away from Gordon Square, where John
Maynard Keynes  one of the greatest economic minds of modern times  lived.
Preparing for this event, I learned that this beautiful venue is sometimes also called the
'Titanic hotel'. The main reason being that the restaurant is said to be almost identical to
the Titanic's dining room. Both were designed by Charles Fitzroy Doll, the hotel's architect,
and also the man who was commissioned to do the firstclass parts of the ocean liner.
Let me say that although I feel the weight of the historical context of this beautiful place,
thankfully I do not see a connection between the euro area economy and the doomed ship.
In fact, the economy has sailed a steady course lately despite high global waves and tight
monetary policy.
 DNB
Starting with inflation, I am confident to say that the inflation peak lies behind us. Chart 
on the lefthand side shows the evolution of euro area headline inflation, decomposed into
its main components since . We see a clear disinflation since late  when inflation
stood at more than %. This largely reflects the unwinding of earlier energy and food
prices spikes, as well as the easing of supplyside bottlenecks. The reduction in goods
inflation from .% to .% has been very strong, too. Only services inflation still stands at
an elevated .%. The next phase of disinflation is likely to be more volatile, because the
large swings in energy prices last year together with the staggered reversal of fiscal support
measures have an impact on this year's inflation readings via base effects.
Chart  provides a more structural decomposition of inflation, based on recent DNB
research. Among the set of models we use at DNB, this one focuses particularly on
capturing supplyside constraints. While the model supports the notion that supplyside
shocks were dominant drivers of the rise in euro area inflation, it still attributes more than
one third of the inflation dynamics to demand shocks. For the disinflation period, the
decline in demand is particularly important. The contribution of demand has narrowed to
less than one fifth relative to the peak. Monetary policy  which is captured here largely as
affecting demand  has thus supported the disinflationary process.
But the reaction of monetary policy has also been important in the face of these supply
side shocks. Even though monetary policy has less effects on supply bottlenecks or on food
and energy prices, the public is particularly sensitive to these salient aspects. As a result, an
extended period of abovetarget inflation and possible second round effects create the risk
that high inflation will become entrenched and, at some point, that inflation expectations
will drift away from the target. A timely return of inflation to target is therefore crucial.
That's why it is important for monetary policy to react forcefully to underline our
commitment to price stability.
 DNB
Taking a step back, many have argued that the ECB was too late in hiking rates. While I,
with the benefit of hindsight, understand where that interpretation is coming from, I would
like to make three points in defence of the Governing Council's response.
First, it is important not to reduce the monetary stance to the policy rates alone. The
Governing Council adjusted its forward guidance long before and tapered its bond
purchases under the APP as early as December .
Second, it is important to note that the energy shocks were a direct consequence of the
unjustified Russian invasion of Ukraine. As such, these shocks were not only
unprecedented, but with a war at the European borders, the uncertainty went beyond
energy prices. In this situation, my colleagues and I on the Governing Council were wary to
choke off the economy in light of possible contractionary effects of the war.
Finally, even if we had initially fallen somewhat behind the curve, the eventual response has
been very forceful and united, thus underlining the Governing Council's commitment to its
% inflation target over the medium term. This interpretation is also supported by a simple
 socalled thick  modelling approach of policy rate paths implied by a large set of Taylor
rules shown here in Chart . Clearly, the ECB's policy rate implied by these simple reaction
functions lifts off later but catches up quite soon.
 DNB
In my view, one key element of the success of monetary policy over the last few years has
been in ensuring that the large inflationary shocks did not cause a deanchoring of
expectations. One way to assess the risk of deanchoring of expectations is this model
based analysis shown here on Slide . In this euro area application, DNB staff assess the
path of inflation that is consistent with anchoring longrun inflation expectations going
forward. As you can see on the lefthand side, at the September  Governing Council
meeting, the projected path of inflation depicted by the green dots was slightly above the
anchoringcompatible path of inflation, the bluedashed line. Therefore, further policy
tightening was justified as this clearly posed an upward risk to inflation. The righthand
side of Chart  shows the same analysis conducted at the March  Governing Council
meeting. As you can see, the latest projected path of inflation is consistent with anchoring
longrun inflation expectations. So, our policy of running a tight ship seems to have paid
off.
Over recent years, policy decisions have been made in an environment of high uncertainty
and large shocks. We knew that icebergs were looming in the dark, but it was hard to
predict where. This uncertainty not only included the inflation outlook and the balance of
risks, but was also related to the transmission of the extraordinary tightening of monetary
policy. The Governing Council has therefore opted to take a datadependent approach.
Underlying this approach are three criteria. First, the inflation outlook in light of the
incoming data. Second, the dynamics of underlying inflation, based on indicators which
remove some of the highfrequency movements in inflation. And third, evidence on the
strength of monetary policy transmission.
The focus on incoming data was particularly important, because making projections in an
environment of high uncertainty is inherently difficult. Not surprisingly then, the forecast
errors of the Eurosystem staff as well as those of other institutions have been sizeable. You
can see this in Chart , which shows the inflation forecast errors from the Eurosystem staff
projections since .
Yet, what's more important than the forecast errors themselves is understanding the
underlying cause of these errors. And as you can see in Chart , the largest part of these
forecast errors can be explained by assumptions about energy prices and their direct and
indirect effects on inflation, indicated by the yellow and red bars. This is not surprising given
the large shocks to energy prices we observed in this sample. Other nonenergy related
errors also play an important role in the latter part of the sample.
I'm convinced that this multipillar approach with a stronger focus on actual data
realisations has served us well recently and that we need to continue to be datadependent
going forward. At the same time, as the decline in forecast errors in Chart  shows, there
are also reasons to regain some confidence in our projections. This, together with the fact
that a lot of the relevant and comprehensive data such as that on wages, productivity and
profit margins are only published on a quarterly basis, suggests to me that projection round
meetings of the Governing Council will be the key meetings for our interest rate decisions.
Currently, the monetary stance remains historically tight. This is not only the case for the
level of policy rates themselves, but also when comparing real interest rates relative to the
natural rate of interest, rstar. Chart  shows this gap between the exante real interest
rate and rstar for the euro area and the US, based on DNB research. Of course, these
estimates always have to be taken with a grain of salt given the sizeable model and
estimation uncertainty as highlighted by the huge confidence bands. But the picture looks
similar across a wide array of Eurosystem models. According to this model, the degree of
monetary tightness is comparable across the two regions.
However, as the disinflationary path in the euro area continues and the mediumterm
inflation outlook further improves, we become increasingly confident that inflation will
return to target in a timely manner. Consequently, it can soon be appropriate to ease the
currently restrictive monetary policy stance, and gradually take our foot off the brake. As a
result, policy rates will slowly but gradually move to less restrictive levels. The precise
timing, speed and scale of easing will also follow a datadependent approach, with our
projections being a key ingredient.
To give you a perspective on the path of policy normalisation based on the March
Eurosystem staff projections, Chart  shows optimal policy scenarios. Optimal here means
that monetary policy tries to minimise the deviations of inflation from target and output
from its potential*. The range, in turn, is based on both a set of models and varying weights
that the central bank attaches to inflation relative to growth. The upper end of that range
thus corresponds to stricter inflation targeting. This means achieving a faster return of
inflation to target, albeit at higher costs in terms of output. According to the chart, the
optimal rate path would prescribe a reduction in the policy rate over the next quarters.
Looking at the horizon until the end of the year, based on the March projections, optimal
policy would have been broadly in line with  rate cuts, similar to the market pricing that
was incorporated into these projections.
It's important to note that these optimal rate paths rely on the inflation projections from
March that include a quite rapid fall of inflation and slightly belowtarget inflation from the
second half of  onwards. This reflects, amongst others, a moderation of wage growth,
a recovery of productivity growth and firms' profit margins that absorb the higher wages.
While the incoming data on new wage agreements does indicate some moderation since
late , wage growth has remained elevated and  according to forwardlooking
indicators  the path for  is still expected to be quite bumpy. Productivity growth has
remained low and is yet to pick up. Hence, we will have to await our next projections in
June that will provide an updated assessment of the inflation outlook and the
accompanying balance of risks.
I am aware I have been throwing a lot of technical stuff at you for the last few minutes, and
I hope you are still with me. In any case, the important takeaway is that, although these
interest rate scenarios can provide useful guidance, given the current environment we still
have to avoid any commitments on a specific future rate path. Waters may still be rough in
the time ahead, so it's too early to declare that we have made a safe crossing. Our data
dependent approach allows us to assess the incoming data and inflation outlook moving
from one meeting to the next and adjust our policy stance accordingly.
Let me stop here. I am looking forward to an insightful discussion. Thank you for your
attention!