(Bloomberg) -- The European Central Bank can no longer afford to ignore supply shocks to the economy as they can leave a lasting imprint on inflation, Executive Board Member Frank Elderson said, adding they’re likely to emerge more often in the future.
“Monetary policy may have to respond more proactively to bottlenecks than has been considered appropriate in the past,” he said on Thursday in Nicosia, Cyprus, referring to potential damage to the economy’s productive capacity caused by geopolitical tensions, economic fragmentation, climate change and nature crises.
Their impact on consumer-price growth may be “more pronounced and long-lasting”, increasing the “risks of inflation expectations becoming de-anchored and of second-round effects in the form of wage-price spirals,” he said. Therefore there’s “less scope for looking through deviations of inflation from our 2% target.”
In the past, central banks including the ECB, tended to widely disregard such shocks assuming they lift price growth only temporarily. But recent years have shown that if there’s a risk of such events becoming larger and more persistent, price expectations can deviate from target regardless of whether the shocks are supply- or demand-driven.
Critics argue that the ECB erred in 2021 by judging that the surge in inflation at that time was temporary, and then was too slow to end net asset purchases and raise interest rates in 2022.
Eldersons’ comments come amid a fresh review of the ECB’s monetary-policy strategy, with results due in the second half of 2025. It’s also likely to investigate how the ECB can best act should supply shocks occur more regularly.
“Many fear that we could face inflationary supply-side shocks more frequently in the future,” Executive Board member Isabel Schnabel said in July. “We should look at how we can reliably fulfill our price-stability mandate in such an environment.”
On Thursday, Elderson also said that bottlenecks will emerge more regularly in the future, adding that “the more important it becomes that the economy can rely on its price stability anchor.”
“We cannot pre-empt exactly what the appropriate policy response to an emerging bottleneck would be,” he said. “Therefore, the flexibility and data-dependency that we have applied in navigating the challenges of the past few years will remain crucial in the years to come.”
(Updates with more comments starting in eighth paragraph)
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