An important voice in the Governing Council.
(Photo: imago images / Jens Schicke)
There have been warnings for a long time that the fight against climate change could drive up energy prices and thus inflation as well. So far, however, this has been viewed more as a longer-term future issue and was less linked to the short- and medium-term inflation problems that arose from the corona pandemic.
Isabel Schnabel, German director of the European Central Bank (ECB), has now established this link – and thus indirectly changed the coordinates of monetary policy. At the same time, Schnabel has thus moved closer to the camp of the hawks, the supporters of a stricter monetary policy. Because she is one of the most prominent figures in the Governing Council, this shift cannot be rated highly enough.
Central banks around the world tend to orient their monetary policy primarily towards what is known as core inflation. Food and energy prices are excluded from this because they fluctuate relatively strongly and therefore, according to the rationale, the underlying trends tend to blur rather than clarify. Exactly this exclusion of energy prices can no longer be the rule because of climate policy and the resulting longer-term price trends – Schnabel made this clear in a speech at the weekend. And that is exactly how the coordinates shift.
It can of course happen that energy prices will calm down again in the coming years while the aftermath of the corona pandemic has not yet been overcome. In that case, Schnabel’s announcement would not change much. If energy persistently becomes more and more expensive, the ECB would have to react more clearly than previously expected if the opinion of the German ECB director prevails.
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Communication becomes more difficult
The challenge that arises in this case is considerable. Because if energy prices rise due to higher costs in production or simply due to scarcity, from an economic point of view this is initially a problem on the supply side – just like the production bottlenecks that are felt today due to Corona. However, monetary policy primarily affects demand. If one reads Schnabel’s approach carefully, then she recommends paying more attention to energy prices, especially in two cases: if the expensive energy should lead to a general expectation of higher inflation or if the economy as a whole is given a boost as a result of new investments. But it will be difficult for the ECB to make all too subtle differences in its communication: once it decides to take energy into account, it will be measured against it.
Important signal for investors
And that’s not the only communication problem that the central bank and its President Christine Lagarde will encounter. One of the ECB’s mantra has so far also been that inflation becomes particularly dangerous when so-called second-round effects occur, i.e. when higher prices result in higher wages and salaries, which in turn drive costs and prices. Many economists assume that wages and salaries will rise significantly in the coming years, if only for demographic reasons. Such an increase in labor costs doesn’t have to be a second-round effect. But if it happens, the ECB’s critics will promptly reproach it with the fact that it shouldn’t hesitate any longer or that it has already reacted too late.
Schnabel tried again and again to make the monetary policy of the ECB understandable to the public and defended the central bank against unobjective criticism. This sometimes hides the fact that, within the ECB, it has so far by no means clearly belonged to the camp of doves, the representatives of a soft monetary policy. As early as the December meeting of the ECB, it apparently criticized internally what it considered to be inflation forecasts that were too low. If their position now shifts even further, that will also be an important signal for investors.
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