speech monetary policy in a cost - of - living crisis speech by isabel schnabel, member of the executive board of the ecb, at a panel on the “ fight against inflation ” at the iv edition foro la toja la toja, 30 september 2022 the euro area is facing a cost - of - living crisis. an increasing proportion of people ’ s income is being spent on essential purchases, such as food and energy. at the same time, price pressures are broadening and nominal wages are not keeping pace with rising prices. the result is a marked loss in people ’ s purchasing power and a decline in the labour share of income, which is the share of total income paid to workers as wages, salaries and other benefits. today i want to make four conceptual points about these developments. first, i will argue that the secular decline in the bargaining power of workers can help explain the decline in the labour share of income, which can be expected to weigh on private consumption and thus dampen aggregate demand. second, i will ask what factors determine the future evolution of real wages and hence how the costs of this crisis are distributed between workers and firms in the future. i will argue that the risks of a wage - price spiral are contained, provided inflation expectations remain anchored. third, i will discuss why a decline in real wages and a slowdown in aggregate demand may not materially ease current inflationary pressures. one reason is that today ’ s energy crisis will suppress both supply and demand. a second reason is that firms will try to protect their profit margins from higher energy costs. my final point relates to the implications for monetary policy. if there is a tangible risk that lower demand will not ease inflationary pressures, there is a strong case for a “ robust control ” approach to monetary policy, guided by the principle of a forward - looking central bank that takes its decisions with a view to stabilising medium - term inflation. wages affect inflation through aggregate demand and cost - push channels the outlook for wages plays an important role in assessing the risks of current high inflation becoming entrenched over time. two channels are most relevant for monetary policy. the first is the aggregate demand channel. real wages determine households ’ purchasing power, and hence affect the outlook for private consumption and prices. the pandemic is a case in point. the fast rebound in real wages following the lockdowns in 2020 has been a key driver boosting demand. ecb staff analysis suggests that res

the energy shock, or whether they will lead to a perilous wage - price spiral, will ultimately depend on the credibility of the euro area ’ s nominal anchor. if long - term inflation expectations remain anchored, the risks of a wage - price spiral will be limited. this is what we have observed so far in the euro area. the ecb ’ s forward - looking wage tracker currently points to further increases in wages, but these are expected to remain at levels that are unlikely to set in motion a harmful wage - price dynamic. therefore, while a close monitoring of wage developments remains essential, at present the most likely outcome remains a further decline in real consumer wages and the labour share of income. our consumer expectations survey points in a similar direction. it found that households anticipate their real wages to fall by around 6 % over the next twelve months ( slide 7, left - hand chart ). inflation may remain high despite a slowdown in aggregate demand this brings me to the second question for monetary policy, namely to what extent a decline in real wages and the labour share will ease current strong inflationary pressures through its effect on aggregate demand. such an endogenous effect on prices would support the efforts of monetary policy to bring inflation back to levels consistent with price stability. there are, however, two reasons to believe that the relationship between the labour share and inflation might currently be blurred – either because the labour share may no longer be a sufficient summary indicator, or because the slope of the new keynesian phillips curve has become flat or statistically insignificant. as a result, underlying inflation may remain high despite weakening demand. lower supply may limit impact of slowdown in aggregate demand on capacity utilisation the first reason relates to the implications of changes in the labour share for changes in capacity utilisation. whether, and by how much, a decline in aggregate demand will create conditions of excess capacity critically depends on the impact of current shocks on the supply side. if, as is likely, both supply and demand weaken, the net impact on economic slack, and hence prices, will be more difficult to anticipate. the damage from the current crisis to the supply side is likely to be significant. [ 19 ] energy - related production cuts and energy - saving measures directly curb potential output, while the sharp increase in gas prices will render some energy - intensive activities unprofitable. insolvencies may rise, and parts of the capital stock may become obsolete. moreover, productivity growth