Speech by Christine Lagarde, President of the ECB, at the hearing of the Committee on Economic and Monetary Affairs of the European Parliament
Brussels, 28 November 2022
Over the past 12 months, the ECB has embarked on a rapid and comprehensive process of monetary policy normalization.
First, we ended net asset purchases within months. Then we started raising our policy rates at their fastest rate ever.
In my brief remarks today, I will briefly reflect on the past year and focus on the main actions taken by the ECB, and more broadly by the EU, to address citizens’ concerns.
I will also address the two topics chosen by this committee for today’s hearing, namely the global monetary policy cycle and inflation differentials.
A difficult year for Europeans
The Russian invasion of Ukraine has caused much human suffering. It has also shaken our sense of security, threatened our energy security, disrupted supply chains and helped push inflation well above our target.
The shock hit just as we emerged from the pandemic and continued to cause economic disruption. The repercussions were felt not only in Europe but also around the world: inflation jumped almost everywhere, prompting central banks to raise interest rates and leading to a rapid tightening of financing conditions around the world.
Given our proximity to the conflict and our dependence on energy imports, Europe has been particularly hard hit. Rising energy costs have been a key driver of eurozone inflation, which in October hit double digits for the first time since the start of monetary union.
While the energy shock and global bottlenecks have constrained supply, the reopening of the economy after the pandemic has led to a rapid release of pent-up demand, contributing to the upward pressure of demand factors on the economy. underlying inflation, which gradually increased over the year.
This rise in inflation affects everyone, but some feel it more than others. I am thinking in particular of low-income people who devote a larger share of their consumer budget to basic necessities such as food, electricity, gas and heating, while having less financial leeway for cover the rising cost of living. Currently, the gap between the effective inflation rate recorded by the lowest and highest income groups is by far at its highest level ever recorded in the euro area.
The divergence in inflation rates among eurozone member countries is also at an all-time high, mainly due to different degrees of exposure to the energy shock and the pandemic. We are watching these divergences carefully and expect them to normalize as the impact of these shocks fades over time.
The various shocks of the past year have also had an impact on real economic activity.
While the reopening of the economy after the pandemic led to surprisingly strong activity earlier this year, growth is now slowing rapidly due to the war.
By reducing the real incomes of individuals and increasing the costs of businesses, high inflation dampens spending and production. High uncertainty, tighter financial conditions and weaker global demand are also weighing on economic growth, which is expected to continue to weaken through the end of the year and into early next year..
Respond to people’s concerns and fulfill our mandate
In the face of these unprecedented challenges, Europe has risen to the occasion and shown a strong sense of unity and solidarity – thanks also to the crucial role played by this Parliament in lobbying favor of truly European actions.
Beyond the provision of financial, humanitarian and military assistance to Ukraine, the European Union has taken important steps to protect us from the consequences of war, to strengthen our resilience and to reduce our energy dependence.
The European response to the war has garnered broad support among citizens and optimism about the future of the EU has grown. Two in three citizens now view their country’s EU membership as a good thing – the highest result since 2007.
Yet the same surveys also show that a third of citizens consider the rising cost of living to be the most important problem facing the EU. And although the majority of citizens believe that defending our common European values must be a priority, even if it has a negative impact on the cost of living, every policy maker should respond to this challenge.
In accordance with its mandate, the ECB plays its role in ensuring price stability. Our third major increase in key rates in October, which has resulted in a cumulative increase of 200 basis points since July, underlines our determination to control inflation. This increase was accompanied by a recalibration of our Targeted Longer-Term Refinancing Operations (TLTROs) to strengthen the transmission of our policy rate hikes to banks’ lending conditions and contribute to the normalization of the Eurosystem.
In December, we will also outline the key principles for reducing bond holdings in our asset purchase program portfolio. The balance sheet should be normalized over time in a measured and predictable way.
Interest rates are and will remain the main tool in the fight against inflation. Higher interest rates reduce demand pressures by making it more expensive to borrow money and by affecting spending, saving, borrowing and investment by individuals and businesses. This will in turn put downward pressure on prices, although the adjustments will take some time to be felt in the economy.
Higher interest rates also have an immediate effect on the expectations of individuals and businesses regarding future inflation, thus protecting them against the risk of second-round effects. Persistently high inflation could lead to unanchored inflation expectations, which would then be anchored in wage negotiations and price setting. The resulting wage-price spirals would not only be self-defeating in sustaining real incomes across the economy, but they would also hamper the productive capacity of the economy as a whole.
Strong labor markets – with the unemployment rate still at a historic low of 6.6% in September – should support higher wages. Forthcoming data suggest wages are picking up, and we will continue to assess their implications for the medium-term inflation outlook.
While monetary policy aims to bring inflation back towards our medium-term target, the economic outlook will also depend on actions taken by other stakeholders.
In the current context of high inflation, fiscal policy must be prudent so as not to aggravate inflationary pressures. Budget support must therefore be targeted, tailored and temporary. It must be targeted, so that the magnitude of the fiscal stimulus is limited and benefits those who need it most; tailor-made, so as not to weaken incentives to reduce energy demand; and temporary, so that the budgetary impulse is not maintained longer than strictly necessary. At the same time, governments should pursue fiscal policies that show their commitment to gradually reducing high public debt ratios.
The execution of the ECB’s mandate will create the conditions for strong and sustainable growth for the benefit of all. However, achieving price stability is a necessary but not sufficient condition. Other policy areas will need to act.
Removing the constraints on economic growth through an ambitious program of economic reforms at European and national levels will not only restore the supply side that has been damaged by recent shocks. It will also, over time, strengthen the resilience of our economy in a world that is becoming less and less predictable.
In this regard, we also welcome the Commission’s proposals to reform the EU economic governance framework. Sustainable fiscal policies are needed not only to ensure medium-term debt sustainability, but also to support the three key transitions that will determine our future and our growth model: towards cleaner energy, greater economic security and more digital and productive economy.
The Commission’s proposals are a good starting point for discussion. I encourage EU policy makers, including this Parliament, to quickly reach a viable and widely shared agreement to help strengthen the foundations of our Economic and Monetary Union.
Allow me to conclude.
We are determined to bring inflation back to our medium-term target and we are determined to take the necessary steps to achieve it. We expect to raise rates further to the levels needed to ensure that inflation returns to our medium-term target of 2% in due course.
In this environment of high uncertainty and complex shocks hitting the economy, Governing Council decisions will continue to be data-driven and take a meeting-by-meeting approach. How far we need to go, and how fast we need to get there, will depend on our updated outlook, the persistence of shocks, the reaction of wages and inflation expectations, and our assessment of our policy transmission .
I now stand ready to answer your questions.
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