philip r lane : disinflation and monetary policy in the euro area dinner speech by mr philip r lane, member of the executive board of the european central bank, at the money marketeers of new york university, new york city, 21 september 2023. * * * introduction in my remarks this evening, i will assess the economic and inflation outlook in the euro area and explain last week's monetary policy decision taken by the governing council of the ecb. before i turn to the most recent developments, let me start by recalling how we got to where we are today. 1 the 2021 - 2022 inflation surge in europe was driven predominantly by an extraordinary combination of shocks. the pandemic generated a staggered sequence of sectoral supply - demand mismatches. especially in 2021, the global rotation of spending from services towards goods - at a time when supply remained hampered by pandemic - related lockdowns - resulted in severe supply chain bottlenecks and fostered exceptional pricing power for producers of in - demand products. in europe, after alternating waves of lockdowns and temporary reopenings, the economy fully reopened in the spring of 2022 at a time when the supply capacity in contact - intensive service sectors ( especially the tourism and hospitability sectors ) had not yet recovered from the prolonged shutdown phase. in parallel, the unjustified invasion of ukraine by russia triggered an extraordinary surge in energy prices ( and attendant terms of trade losses ) that peaked in august 2022. the scale and breadth of these shocks generated extraordinary shifts in sectoral relative prices. in principle, fluctuations in sectoral relative prices can be accommodated with no change in the overall inflation rate. however, in the presence of downward price rigidities and downward wage stickiness, this would have required an enormous tightening of monetary policy and depression of output. together with the inevitable time lags in monetary policy transmission, this is the fundamental reason why central banks focus on medium - term inflation rather than seeking to deliver the inflation target continuously. in the euro area, inflation peaked at 10. 6 per cent in october 2022. the peak inflation rate would have been even higher in the absence of the significant fiscal subsidies rolled out by euro area governments in the final months of 2022. during 2023 many of these factors have reversed : energy prices have come down sharply from their peaks ; supply conditions in global manufacturing and global trade have normalised ; and demand - supply mismatches in contact - intensive sectors

area countries. a number of countries have lowered marginal tax rates in order to make their tax systems more employment - friendly. many countries have targeted tax cuts at the lower end of the labour market in particular. these measures have contributed to a higher demand for low - skilled workers. nevertheless, marginal tax rates still remain high in some countries. some progress has also been made with the introduction of part - time or more flexible working contracts and practices. in addition to government policies, there are signs of a gradual change in labour market behaviour related to the wage formation process. discipline seems to have improved in that field over the past decade. such a change, resulting from lower inflation expectations, is important. furthermore, there seems to be a growing awareness that, in a single currency environment, the price increases and loss of competitiveness generated by excessive wage settlements cannot be compensated by an exchange rate depreciation and may directly result in a loss of jobs. looking ahead, it is crucial that social partners continue to adhere to moderate wage developments, since this is one of the prerequisites in fostering employment and maintaining a favourable outlook for price stability in the medium term. in this respect, there is some cause for concern with regard to ongoing wage negotiations. the wage formation process also seems to have undergone changes. in a majority of euro area countries, there are signs of a gradual trend towards more decentralised bargaining and more flexibility at lower bargaining levels. this seems to happen, mostly informally, through clauses that allow firms to deviate from the sectoral or central wage agreements according to the financial situation of the firm or sector. this is encouraging. the outcomes of wage bargaining should allow not only for appropriate wage developments in the overall economy, but also for adequate wage differentiation across sectors, regions and firms. this will make it easier to account for local conditions, such as unemployment, productivity or profitability differentials across sectors, regions and firms. in short, labour market reforms have, in general, been going in the right direction in recent years and the benefits of these positive developments are clear. however, progress has been rather uneven across countries and areas. in many areas important reforms have not yet got off the ground. for instance, few changes have been made regarding employment protection policies in euro area countries, which remain amongst the strictest in the industrial countries. furthermore, in almost all euro area countries, reforms targeting unemployment benefit systems have only made slow progress. at the same time, significant mismatches between