Inflation and monetary policy at the European Union

Fabio Panetta, member of the Executive Board of the European Central Bank (ECB), describes the tough balance of the monetary response to deal with the uncertainty about inflation and economic growth outlook, exacerbated by the Ukraine’s conflict. If the ECB reacts to a rise in inflation that might not be lasting, it could suffocate the recovery, if it is too timid it could fail to ensure price stability, which would also have a negative impact on economic growth.

Key messages of the speech:

• The good, the bad and the ugly inflations: Fabio Panetta comments that there are 3 kinds of inflation:

- The good: driven by domestic demand and wages consistent with ECB´s target, which monetary policy should seek to nurture until that target is reached

- The bad: reflects negative supply shocks that raise prices and depress economic activity, which monetary policy should look through

- The ugly: the worst type of inflation – is driven by a de-anchoring of inflation expectations, which monetary policy should immediately stamp out and combat.

• The bad inflation is still dominating in the euro area today: uncertain about its lasting, but temporary and driven by exports.
  
  
• However, the Ukraine conflict adds more uncertainty. It could make this bad inflation higher for longer and therefore limiting the economic recovery, but it could also destabilize inflation expectations, feeding into wage negotiations and domestic price pressures, turning bad inflation into ugly inflation. 
  
  
• The monetary response dilemma: The ECB must accompany the recovery with a light touch, taking moderate and careful steps in adjusting policy, so as not to suffocate the yet incomplete recovery and to not fail in ensuring price stability.