Most of the work has already been done: Eurozone inflation has fallen from double-digit levels, inappropriate for a developed economy, to below 3%. Just nine tenths of the 2% target. Since November, Christine Lagarde has been working to dispel what the bank believes are too early expectations of interest rate cuts.
We know central bankers well and their tendency to be spoilsports, like a strict father who threatens to ban his children from a birthday party even though he knows that barring a disaster, they will attend. But it's no coincidence that in recent weeks there has been talk of the last mile of inflation: for those who run a marathon, the last kilometer, with the finish line in sight, is the hardest. From an economic point of view, in this section it is more difficult to influence prices and therefore additional sacrifices are required in terms of growth and employment.
Even under the winter economic climate in Germany (and even worse expectations according to the IFO), Frankfurt continues to struggle with prices. A month ago, ECB Executive Board member Isabel Schnabel suggested in an interview with the Süddeutsche Zeitung that inflation must fall below 2%. “We have to go the last mile; “We have an inflation target of 2%,” he stated. Asked whether 2.1% would be enough, she replied: “We need to return to 2% in a sustainable way.” Although the ECB's mandate has been symmetrical since 2021 (2.1% or 1.9% would not matter), The statements of those responsible are not.
Yesterday, Lagarde stressed that the economy was behaving as expected and the bank would therefore not change course. The bank's forecasts suggest that both the overall Eurozone CPI and the underlying CPI will weaken to around 2.5% in the second quarter of the year, but will not fall to 2% until well into 2025 .
The monetary authority pays particular attention to salaries. Klaas Knot, chairman of the Financial Stability Board (FSB), noted this month that he needs to turn around wages before cutting interest rates. Lagarde put it into perspective yesterday: “We are seeing a slight decline in the growth rate […] “We don't want it to fuel inflation, and that's exactly what we're seeing.” It remains to be seen how much time the ECB needs to ensure that these effects don't occur, as it runs the risk (as will happen the other way around in 2022). case) to come into the game too late.
Other key elements for the bank also point towards moderation. The ECB's own bank lending survey pointed to a “strong transmission of monetary policy”. On the supply side, banks are turning off the tap according to all criteria, while at the same time ensuring that demand for credit “decreases significantly” (in the words of the ECB itself). In this way, energy price futures also do not indicate inflationary pressure; rather the other way around.
The Eurozone CPI is nine tenths above target, while growth in Germany is stagnating
Georgieva (IMF), Schnabel, Lagarde, Powell (Fed) and Dave Ramsdem (Bank of England) have recently cited the difficulty of the last mile. This is the orthodox position, based on three arguments: First, the Phillips curve (which captures inflation data on the vertical axis and employment data on the horizontal axis) is nonlinear and becomes almost flat as inflation falls. Second, inflation is higher in services than in consumer goods. And third, if inflation expectations are anchored at a level above 2%, inflation will tend to rise to that level.
According to a recent paper from the Atlanta Fed, there isn't much evidence of this; The last mile is significantly different from the rest of the race, so it is not necessary that monetary policy is also different. “The belief that the last mile is more strenuous could lead the Fed to tighten policy more than necessary, increasing the likelihood of a recession and a sharp rise in unemployment,” he notes.
The asymmetric approach is not in vain, because doing nothing already means doing something, and although the inflation path seems reasonable, the same cannot be said for growth. Central banks have their ghost of Christmas past in entrenched inflation, but as in Dickens' story they can see the specter of recession as the ghost of Christmas future.
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