get a better sense of the evolution of the hicp over the medium term, we need to complement our analysis also by looking at more cyclical and less volatile measures of inflation, such as underlying inflation. the public rightly expects us to defend the purchasing power of money and that is https : / / www. ecb. europa. eu / press / key / date / 2020 / html / ecb. sp200930 ~ 169abb1202. en. html 2 / 7 30 / 09 / 2020 the monetary policy strategy review : some preliminary considerations why we target the overall hicp. but underlying inflation measures are more responsive to economic slack and tend to better predict inflation over the medium term. the relationship between inflation and the real economy if the anchor for inflation is the inflation aim, the phillips curve – the link between the real economy and inflation – plays a central role in allowing central banks to steer inflation towards that aim. but in the low inflation environment, prices appear to have become less responsive to the real economy. ecb research suggests that the empirical phillips curve remains intact, but it may be rather flat. broadly speaking, three factors might explain why inflation responded so weakly to improvements in the economy in the run - up to the pandemic. the first possibility is that economic slack – the amount of underused resources in the economy – was larger than we thought. the second possibility is that the relationship between slack and inflation was obscured by persistent structural forces. and the third is that the anchoring of inflation expectations might have loosened, affecting where inflation settles when both demand and supply shocks have passed and slack converges at zero. the intuition behind the first factor is that the phillips curve is alive and well, but the euro area faced a series of large shocks that made it harder to measure economic activity relative to potential. since it is the distance from full employment that matters in terms of moving inflation in the phillips curve, if that distance is underestimated inflation may remain subdued even as measured slack gets smaller. there are numerous potential causes of this mismeasurement, including : measures of unemployment that ignored the effects of part - time work and underemployment [ 5 ] ; revisions to potential output which mistook cyclical changes for structural trends [ 6 ] ; or a failure to fully account for external factors that added to euro area slack, such as relative demand imbalances linked to the trade surplus. [ 7 ] research supports such a role for

a long time to absorb new information on inflation, but when their expectations do adjust they can be hard to dislodge – and the direction in which people perceive inflation to be heading can affect their economic decisions. this process is of course not exogenous to monetary policy : it is greatly influenced by the central bank ’ s objective and how policy is conducted and communicated in the pursuit of that objective. this is why the discussion about the numerical definition of price stability and the instruments that can support it over time is so important. clearly, the three factors i have discussed are not mutually exclusive. so it is crucial that we gain a much deeper understanding of their relevance and interactions in order to draw appropriate conclusions for how we conduct our monetary policy. as part of this, we need to understand how they might have interacted with monetary policy approaching the lower bound. this brings me to the final area i would like to discuss today : monetary policy transmission and effectiveness. monetary policy transmission and effectiveness as monetary policy everywhere has approached the lower bound, all major central banks have faced questions about their policy space and the traction of their tools on the economy. a key challenge has been the long - term fall in estimates of the natural interest rate. the natural rate is the unobservable interest rate that brings desired saving and investment into balance, or to put it another way, that brings output close to its potential. monetary policy is accommodative when the policy rate is below the natural rate, and restrictive when the policy rate is above it. estimates for the natural rate in the euro area have dropped from between 0. 6 % and 2. 2 % on average from 1999 to 2011, to between - 1. 3 % https : / / www. ecb. europa. eu / press / key / date / 2020 / html / ecb. sp200930 ~ 169abb1202. en. html 4 / 7 30 / 09 / 2020 the monetary policy strategy review : some preliminary considerations and 0. 5 % thereafter. [ 16 ] this has required progressively lower policy rates in order to ease monetary policy – or even to prevent an unchanged policy stance from becoming more restrictive. central banks around the world have shown that this is not a barrier to stabilising the economy. before the pandemic, the ecb was able to offset the effects of a declining natural rate by taking its deposit facility rate into negative territory and by deploying forward guidance and asset purchases to ease