“ the quest for policy scope : implications for monetary policy strategies ” speech by klaas knot at the fourth annual high - level conference racing for economic leadership : eu - us perspectives new york, 16 october 2019 in new york, at the 4th annual high - level conference on eu - us perspectives, klaas knot participated in a session “ the quest for policy scope ”. mr knot highlighted implications for monetary strategies, by discussing how longer - term changes in the global economy continue to create important challenges for monetary policy. these challenges have gained in relevance over time. they should be important elements of future reflections on monetary policy strategy. more than a decade after the global financial crisis erupted, inflation in the euro area has still not reached the ecb ’ s aim of below, but close to, 2 %. this despite unprecedented conventional and unconventional monetary easing and five years of economic expansion. moreover, market - based indicators of long - term inflation expectations in the euro area have fallen, fueling concerns that the anchoring of inflation expectations may have weakened. against the backdrop of a weakening global economy and heightened geopolitical risks, these concerns prompted the ecb to take further measures to boost inflation at its september meeting. a lot has been said and written about the desirability of this package of policy measures. last week the ecb published the account of the meeting, which includes an extensive overview of the arguments exchanged in its governing council. today i do not want to dwell anymore on the merits of the policy package or its individual elements. rather, i would like to look ahead and discuss how longer - term changes in the global economy continue to create important challenges for monetary policy. these challenges relate to the controllability of inflation by monetary policymakers. i will argue that these challenges have gained in relevance over time. i therefore believe they should be important elements of future reflections on monetary policy strategy. some of these challenges affect all central banks, while others are specific to the institutional context in which the ecb operates. setting the stage to set the scene, let me first present two stylized facts on long - run inflation dynamics. first, low and falling inflation is not a recent phenomenon. at dnb we have performed an analysis that decomposes inflation in a time - varying trend and a cyclical component [ figure 1 ]. the results show that inflation has been subject to a renewed downward trend since the crisis. this differs from the episode that is known in the literature as the great moderation

when there was no significant up - or downward trend in inflation. figure 1 euro area hicp inflation and its trend percent notes : the trend is estimated by an unobserved components model of hicp inflation and the unemployment rate for the euro area, see bonam et al. ( 2019 ). second, not only has inflation been subject to a downward trend, but also its inertia – or persistence – has increased since the crisis [ figure 2 ]. after having declined gradually between the mid - 1980s and the early 2000s, inflation persistence is now back at its long - term average. figure 2 euro area hicp inflation and its persistence percent notes : inflation persistence is estimated from a time - varying autoregressive model over a 30 - quarter moving window for seasonally adjusted, quarter - on - quarter euro area headline inflation. the graph shows hicp inflation ( in percent ) together with the inflation persistence parameter. the vertical bar shows the start of the gfc. for details, see bonam et al. ( 2019 ). the million dollar question is then what these developments signal for central banks ’ ability to control inflation. let me explain my take on this issue. notwithstanding the ongoing debate on its validity, i still regard the phillips curve as a relevant analytical framework to structure our thinking. according to the standard view, the phillips curve explains the inflation process in terms of three main elements. the first element is expectations of future inflation. expectations can be forward - looking, in which case inflation is self - equilibrating ; or backward - looking, in which case inflation is more persistent. the second element is economic slack, which captures the impact of aggregate demand. while slack has traditionally been measured by an output gap or unemployment gap, recent research suggests that more granular indicators of labor market conditions are needed to better capture phillips curve relationships in the data. 1 the third element is shocks. these shocks can in principle have a positive, negative or ambiguous effect on inflation. if shocks are more permanent, inflation will be more inertial. if we look back at the euro area over the past decade, most of these shocks appear to have been quite persistent and have 1 see e. g. aaronson, s., cajner, t., fallick, b., galbis ‐ reig, f., smith, c. and w. wascher ( 2014 ). labor force participation : recent developments and future prospects, brookings papers on economic