severe lockdowns but are now experiencing high demand, such as in hospitality. however, the nature of such bottleneck - induced inflation is that there is an inherent temporary component. in particular, demand - supply mismatches should be alleviated over time through the expansion of supply capacity, together with some normalisation of demand patterns following the reopening. all else equal, if lack of supply is putting upward pressure on prices today, the introduction of extra supply over time will operate in the opposite direction as an anti - inflationary force. the expansion of supply capacity can also be expected in domestic labour markets, through the reversal of the pandemic - related drop in the labour force participation rate and the return of many international workers that had temporarily gone back to their home countries. third, the largest single contributor to the currently - high inflation rate has been the surge in energy prices. while energy inflation has been influenced by both base effects ( energy prices dropped sharply in 2020 ) and bottleneck effects ( demand - supply mismatches have been extensive for both oil and natural gas ), the contribution of energy to overall inflation is typically stronger in the near term than in the medium term, also due to the adverse macroeconomic impact of high energy prices. in particular, since the euro area is a significant net importer of energy, an increase in global energy prices constitutes a negative terms of trade shock, depressing the net revenues of european firms and the disposable income of european households. this adverse aggregate demand channel means that an energy price shock can simultaneously raise headline inflation but, all else equal, exert downward pressure on the path of underlying inflation. 2 taken together, these three forces explain why inflation is temporarily high and provide solid reasons to expect inflation to decline through the course of next year. in relation to the connection between our inflation analysis and our interest rate policy, it is always necessary to keep in mind that monetary policy affects the inflation rate only with a considerable lag. in particular, an abrupt tightening of monetary policy today would not lower the currently - high inflation rates but would serve to slow down the economy and reduce employment over the next couple of years and thereby reduce medium - term inflation pressure. given our assessment that the medium - term inflation trajectory remains below our two per cent target, it would be counterproductive to tighten monetary policy at the current juncture. in particular, our new forward guidance specifies three conditions that need to be met before we would start raising our policy

philip r lane : inflation in the short term and in the medium term welcome address by mr philip r lane, member of the executive board of the european central bank, at the ecb conference on money markets, 8 november 2021. * * * welcome to our annual conference on money markets. this is a prominent event in our calendar : it is difficult to over - state the importance of understanding money markets for the design and implementation of monetary policy. money markets are a seismograph for central bank liquidity conditions and market expectations of future policy, while money market rates are central to the transmission of monetary policy through their impact on economy - wide financing conditions. in recent weeks, there has been volatility in money markets around the world, as traders work to absorb the implications of the recent increase in inflation rates for central bank policy decisions. at the ecb, our decision - making is guided by our new monetary policy strategy, as demonstrated by the revision of our interest rate forward guidance that we decided in july. a central element in our monetary policy strategy is the principle that if the economy is close to the effective lower bound it is necessary to adopt especially forceful or persistent monetary policy action to avoid negative deviations from the inflation target becoming entrenched. despite the high current inflation rate, the analysis indicating that the euro area is still confronted with weak medium - term inflation dynamics remains compelling. in particular, the backdrop of the adverse demand shocks and positive supply developments during the pre - pandemic period — in which inflation averaged just 0. 9 percent between 2014 and 2019 – has had a persistent impact on price - and wage - setting dynamics. in 2020, the inflation rate further declined to 0. 3 percent on account of the initial adverse pandemic shock to the economy and inflation. the euro area has been confronted for an extended period with extensive slack and weak medium - term aggregate demand conditions, as reflected in the chronically - large aggregate current account surplus. while fiscal policy has been forcefully counter - cyclical during the pandemic ( including the launch of the innovative next generation eu initiative ), the capacity of fiscal policy to support aggregate demand dynamics over the medium term is constrained by high aggregate national debt levels and the absence of a permanent central fiscal capacity. these factors reinforce our strategic assessment that extensive monetary accommodation is required to ensure that inflation pressure builds up on a persistent basis in order to stabilise inflation at two per cent over the medium term. how do we reconcile the current high