IIt must be recognized that it is difficult to pass judgment on the evolution of the policy of the European Central Bank (ECB), announced in mid-December 2021 and implemented from March 2022. The ECB has ended the government bond purchase programs between March and June, then increased the key rate by 200 basis points between July and October. In fact, the objective of monetary policy in the euro zone is limited to price stability, ie an average annual inflation rate of 2%.
We can therefore first of all understand the restrictive reaction of the ECB when the price dynamics accelerated at the turn of the years 2021-2022. The thesis of temporary inflation has been replaced by that of a structural phenomenon that could lead to a medium-term reversal of price stability expectations. In addition, the restrictive U-turn announced by the US Federal Reserve in November 2021 immediately raised the interest rate curve on the markets, so much so that a passive attitude by the ECB would have jeopardized its control over the transmission of its Monetary Policy.
But the problem is that, at least in the euro zone, the restrictive monetary response cannot reach the 2% inflation target until it has caused a severe recession.
Fourth recession in fifteen years
Unlike the United States, the origin of European inflation is linked to bottlenecks on the supply side rather than an excessive increase in demand. Cuts in international value chains, caused by the pandemic and concentrated on energy and other strategic raw materials, have been more persistent than expected. In addition, the war in Ukraine greatly aggravated these pre-existing imbalances and triggered a downward trend in supply. The restrictive monetary policy that the ECB is pursuing cannot directly correct these negative data on the supply side. It is only in a position to limit upward price adjustments by reducing demand, that is to say by causing a fourth recession in fifteen years in the euro zone…
Jean-Paul Fitoussi’s criticism of the ECB’s new monetary policy was even more radical than mine when we were debating it. However, our common view was that the ECB found itself between a rock and a hard place: its institutional objective (price stability) would have justified, in principle, a severe monetary restriction; but such a policy would have too high a long-term economic and social cost. Our forecast was that the ECB would make a compromise, i.e. a gradual monetary restriction leading to a situation of stagflation [croissance atone et inflation forte simultanément].
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