Navigating stormy waters: reflections on monetary policy

The European Central Bank’s outgoing official describes a decade-long shift from persistently low inflation to recurrent inflationary shocks, alongside a tightening cycle and rising geopolitical fragmentation. The transition challenged long-held assumptions about inflation dynamics and policy tools, prompting a reevaluation of how central banks respond to rapid changes in economic conditions.

Central banks, including the ECB, initially underestimated the structural forces suppressing inflation, such as globalisation and weak demand from past crises. After the pandemic, inflation repeatedly exceeded forecasts, revealing flaws in analytical frameworks that failed to account for broad-based price pressures and firms’ profit-driven pricing strategies.

The pandemic marked a structural break, altering the global savings-investment balance and increasing both public and private borrowing. This shift contributed to upward pressure on inflation and the natural rate of interest, complicating monetary policy decisions in an environment of heightened uncertainty.

The official warns against rigid policy commitments, citing the ECB’s forward guidance during the pandemic as overly restrictive. Flexibility in policy design is emphasized, with a call to avoid over-reliance on specific models or economic outlooks that may quickly become outdated in a changing world.