Making ECB monetary policy fit for bad times

The European Central Bank's (ECB) monetary policy strategy from 2021 focuses on preventing inflation that is, in its view, too low in the long term. However, in the future, high inflation is much more likely. The ECB should take this into account in its ongoing revision of its monetary policy strategy. When the next inflation shock hits, the ECB must not remain on the sidelines as it did in 2021/22.

Supply shocks have become more likely ...

There are strong arguments that the risks have shifted permanently towards higher inflation. After all, shocks that suddenly reduce the supply of goods and drive prices upwards have become more likely. For example, Donald Trump's massive tariff increases could trigger further trade conflicts. This could happen if the EU retaliates with tariffs against China flooding the EU with goods it can no longer export to the USA. Higher tariffs would then make imports more expensive in the EU and fuel inflation. Additionally, the military withdrawal of the Americans from Europe and other regions could increase the likelihood of crises and wars that disrupt supply chains and raw material deliveries, causing inflation to rise quickly. Sudden shortages and price spikes in food have already become more frequent due to climate change.

... and could trigger more frequent periods of high inflation in the future

Such supply shocks could trigger prolonged periods of high inflation in the future. Many economies suffer from labor shortages due to the shrinking share of the working-age population. Trade unions are in a strong negotiating position and can enforce significantly higher wage increases, which can turn temporary inflation shocks into multi-year periods of high inflation.

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