European Regulators Discuss EU Inflation Tolerance

According to the results of the annual forum of the European Central Bank (ECB), the view of the regulator on inflation in Europe may change. Everything is in place to temporarily accept higher EU inflation as acceptable, from the need for a costly accelerating green energy transition in Europe and financing Ukraine, to a restructuring of international logistics and growing pressure to continue to raise wages in the EU to compensate the population for the shocks of recent years. The possibility of compromises in the fight against rising prices in Europe has clearly increased, and tolerance for inflation can be a competitive EU response to the expected strengthening of the US economy.

The annual ECB forum, a three-day conference that has long been a forum for global monetary regulators, has opened in Sintra, Portugal. This year, the heads of the US Federal Reserve, the Bank of England, the Bank of Japan and the IMF leadership are taking part in its work. The head of the ECB, Christine Lagarde, spoke at the opening of the forum on the evening of June 26 with moderate and vague, but rather hawkish remarks that slightly strengthened the euro, and even yesterday her comments were rather devoted to the need to extend the period of rigidity of the ECB’s monetary policy – but not tightening as such, while the head of the regulator rather expressed an unpopular opinion in this audience. The main discussions in Sintra take place on 27–28 June. The ECB published the main working reports the day before, which can be used to judge the topics of the forum, and first of all, this is the question of the future of European inflation and the strategy of the regulator of the second world currency, the euro, in stabilizing prices.

Thus, the report of ECB economists Robert de Santis and Grigor Stoevsky discusses the current macro situation in the euro area – “The role of supply and demand in the post-pandemic recovery in the eurozone”, this is the de facto official point of view of the ECB on the problem of inflationary pressure that is more stable than previously expected by the regulator in Europe; it extends, however, beyond the euro area – to the UK, the Scandinavian and Balkan countries, Poland, Hungary and the Czech Republic. ECB economists insist that the “covid” policy of the regulator, which took on part of the business risk in 2020-2021, was fully justified, the labor market in the EU, and especially in the euro area, is now in better condition than before the pandemic, as and household finance. The problems of the euro area economy, which are reflected, among other things, in increased inflation, are defined as “bottlenecks” (bottlenecks, primarily in the automotive industry).

The trigger for the generalization of the problem was high energy prices from the fall of 2021, then uncertainty “supported the Russian invasion of Ukraine”, which slowed down economic growth.

Now, de Santis and Stojewski believe that ECB and EU government stimulus policies have led to a normalization of savings, which supports demand, and some tightening of monetary policy by the ECB and banks – lending conditions in Europe, “presumably moistened” the ground for growth in consumption and private investment. In other words, ECB economists describe a situation that is basically similar in design to how the Bank of Russia describes it for the Russian Federation in recent months (expected temporary and slight “overheating” due to supply lagging behind demand growth). By this logic, tight monetary policy in the euro area is debatable and threatens to undermine the growth of its economy.

The reports for the forum in Sintra prove that when solving the medium-term tasks of the ECB (its main mandate as a regulator is price stability), it is necessary to take into account the long-term tasks of the European Union itself. Richard Baldwin of the Graduate Institute in Geneva notes that the phenomenon of “globalization of HIPC inflation” and the growth of industrial production robotization reduce the risks of central banks losing control over inflationary sentiment. Economists of the US Federal Reserve come to similar conclusions in their report. A group of ECB and IMF economists led by Pierre-Olivier Gourenchas proves that the possibilities of the “unconventional” policy of large economies in the fight against a high inflationary background are rather underestimated. LSE’s Silvana Teneiro and Fed’s Annette Wissing-Jorgensen speak of a “volatile inflationary environment” in their reports as a given for Europe in the coming years, as does Norges Bank’s Hilda Bjornan, suggesting elevated inflation expectations after the 2022 “Russian” shock years will remain in Europe for a long time and there is no need to fight it hard. Francesco Lippi of LUISS University demonstrates gaps in neo-Keynesian models in relation to pro-inflationary energy shocks, arguing that the suboptimal structure of economies in the EU, which is being rebuilt on the go, allows the use of large reserves of additional growth, up to 3% of euro area GDP. John Mullebauer from Oxford demonstrates the importance for Europe of the development of real estate markets and the growth of its value (and – the secondary importance of “managedly increased” inflation).

ECB representatives in Sintra yesterday acted as co-authors of reports or moderators. Nevertheless, there were no theses hawkish in relation to higher inflation, and in the remarks and statements “on the sidelines” of the forum, the discussion of the admissibility of higher inflation was almost universal. The information background was the discussion by politicians and the media of “green inflation”, which will allow faster implementation of the green transition in the EU energy sector, and therefore one should be calm about the increased inflationary background. Also, inflation tolerance in the euro area is implicitly seen as one of the tools to compete with the United States and their “Inflation Control Act” of 2023, which is also essentially pro-inflationary. Note that the comments of the head of the Fed, Jerome Powell, and the deputy head of the IMF, Gita Gopinath, were significantly tougher than the comments of the ECB representatives.

A simplified but illustrative example of the Euro mood in Sintra can be considered the statement of the Minister of Economy of France on Radio J on June 26: “When the crisis is over, will our inflation drop to pre-crisis, zero? The answer is no.” Green tasks require its preservation. Economists in Sintra are essentially saying the same thing, albeit in more detail. The ECB’s inflation target will remain at 2%. But rigidity in achieving it conflicts too much with both the general mood and the short-term goals of political Europe: other things being equal, less attention will be paid to it.

Dmitry Butrin