For a long time, central bankers were considered the last savior, always coming up with a good solution when the world slides into an economic catastrophe. That certainty seems to be gone, and that with a problem that is the central task of the monetary authorities: the fight against high inflation. “It is unlikely that any central bank will be able to say with absolute confidence that interest rates have peaked anytime soon,” said ECB President Christine Lagarde at the opening of the ECB’s central bank forum in Sintra. The Portuguese city is hosting this meeting for the tenth time.
Lagarde’s cryptic words reveal the currency guardians’ uncertainty as to how strongly the high prices will settle in all areas of the economy in the coming months and years – and how much interest rates will have to rise. In July, the key interest rate is expected to rise again from the current four percent. What comes next? One does not know. Finding the right “level” and “duration” of high interest rates is “crucial,” said Lagarde – but that can only be decided ad hoc based on current data.
Belgian central bank governor Pierre Wunsch is a member of the Governing Council. He, too, set out for the windswept, hilly landscape of Sintra in order to reconcile the demands and reality of monetary policy. Inflation in the euro zone is 6.1 percent, the central bank target is 2 percent. Is this realistic? “We have to accept that our ability to fix inflation at exactly two percent is limited,” says Wunsch der Süddeutsche Zeitung. In the past ten years, inflation in the euro area was first too low, now it is too high. “We have not reached the target of exactly two percent. I am in favor of the inflation target of two percent, but we need more leeway,” Wunsch said. “If inflation is 2.3 percent and the economy is weak, I would not tighten monetary policy any further.”
“The oil crisis of the 1970s was the last time the world saw such a surge in inflation. That was 50 years ago and it was also due to a supply shock,” says Wunsch. Financial crises happened more often than such stubborn surges in inflation. “So things like this happen, and predicting something like that with our models is not very likely. But if it does happen, the central bank has to react to the price shock early enough. In retrospect, the ECB hesitated too long.”
In the academic debates on the first day of the event in Sintra, the word “humility” came up again and again. Central bankers discuss the limits of their power. They experience things that shouldn’t happen: Unemployment is still very low despite high interest rates. Consumers who saved money during the corona pandemic are buying vigorously, even though prices have risen sharply. Companies make big profits because they add more to their prices than inflation would actually dictate.
“Real wages are now rising back to 2019 levels”
“Inflation is working its way through the economy because economic actors are trying to pass the additional costs on to others,” Lagarde said. Added to this are the rising wages. “Our projections say that real wages will increase by 14 percent by the end of 2025.” The desire of workers to get higher wages is understandable, as real wages have fallen in recent years. “Real wages are now rising back to the level of 2019, workers have not received real wage growth for four years,” says Belgian central bank governor Wunsch, who considers this process to be “fair”. His concern is that wages could rise even more. Behind this is the fear of a wage-price spiral. In it, companies add the higher labor costs to prices, which in turn entails higher wage demands, in other words, inflation would feed itself.
The growing “humility” at the ECB is also a result of the late reaction to rising inflation rates. For too long, the leadership thought that the supply shock resulting from the production losses caused by the corona lockdown and the energy shortage caused by Russia’s war against Ukraine was “transitory”, i.e. it would pass. People had become accustomed to the low inflation of the last ten years, so they couldn’t imagine that prices could suddenly rise sharply.