Isabel Schnabel: Monetary policy in a world of overlapping shocks

Speech by Isabel Schnabel, Member of the Executive Board of the ECB, at the 8th Annual EC-EIB-ESM Capital Markets Seminar

Inflation is back and weighing once again on people’s everyday lives. Just as the euro area was putting the post-pandemic inflation surge behind it, new shocks have hit.

For monetary policy, this sequence of shocks poses challenges. It can affect the behaviour of households and firms, the formation of inflation expectations and, ultimately, the persistence of inflation.[1]

The ECB has adapted to this shock-prone environment in two ways.

First, as of 2023 we have made our monetary policy framework more transparent by laying out our reaction function – that is, the factors that the Governing Council uses to determine the appropriate monetary policy stance: the inflation outlook and the risks surrounding it, the dynamics of underlying inflation and the strength of monetary policy transmission.

ECB President Lagarde has referred to this as “framework guidance”.[2]

By clearly explaining what we are doing and why, we foster public trust in our commitment to maintaining price stability in an environment in which inflation has become more salient.

Second, based on this framework, we have taken timely action in response to the deterioration in the inflation outlook since the start of the Middle East conflict.

Since June, the Governing Council has raised the key ECB interest rates by 50 basis points, lifting the deposit facility rate from 2% to 2.5%, to ensure that inflation will return to our 2% target over the medium term (Slide 2, left-hand side).

Our decisions have been well-anticipated and are being transmitted smoothly to financing conditions.

Framework guidance was instrumental in containing excess volatility by reducing uncertainty about our reaction function, while encouraging investors to form their own assessment of the incoming data.