Most of the work has already been done: euro zone inflation has gone from moving in double-digit areas, inappropriate for a developed economy, to being below 3%. Just nine tenths of the 2% target. Since November, Christine Lagarde has worked to banish expectations of rate cuts that were established, in the bank's opinion, too soon.
We know central bankers well and their tendency to be spoilsports, like a stern father who threatens to ban his children from a birthday party knowing that, barring a catastrophe, they will attend. But it is no coincidence that in recent weeks references to the last mile of inflation have proliferated: for those who run a marathon, the last kilometer, with the finish line in sight, is the hardest. In economic terms, in this section it is more difficult to twist the hand of prices and therefore an extra sacrifice is required in terms of growth and employment.
Thus, even under the winter economic climate in Germany (and even worse expectations, according to the IFO), Frankfurt continues to struggle with prices. A month ago, the member of the Executive Committee of the ECB, Isabel Schnabel, in an interview with the newspaper Süddeutsche Zeitung indicated that inflation must fall below 2%. “We must walk the last mile; “We have an inflation target of 2%,” she indicated. Asked if 2.1% would be enough, she replied that “we must return to 2% in a sustainable way.” Although the ECB's mandate is, since 2021, symmetrical (2.1% or 1.9% would not matter), the statements of those responsible are not.
Yesterday Lagarde insisted that the economy is behaving as expected, so the bank will not change its course. The bank's forecasts suggest that both the general CPI of the eurozone and the underlying CPI will moderate to around 2.5% in the second quarter of the year, although they would not drop to 2% until well into 2025.
The monetary authority is particularly attentive to salaries. Klaas Knot, chairman of the Financial Stability Board (FSB), noted this month that he needs to see a turnaround in wages before lowering rates. Lagarde qualified it yesterday: “We are seeing a slight decrease in the rate of growth […] “We want it not to fuel inflation and that is what we are seeing.” It remains to be seen how much time the ECB needs to ensure that these effects do not exist, as it runs the risk (as happened, conversely, in 2022) of being late to the game.
Other key elements for the bank also point to the path of moderation. The survey of bank loans prepared by the ECB itself pointed to a “powerful transmission of monetary policy.” On the supply side, banks are turning off the tap according to all criteria while ensuring that the demand for credit “decreases substantially” (in the words of the ECB itself). Energy price futures, likewise, do not indicate inflationary pressures in this way; rather the other way around.
The eurozone CPI is nine tenths above the target, with growth flat in Germany
Georgieva (IMF), Schnabel, Lagarde, Powell (Fed) and Dave Ramsdem (Bank of England) have recently cited the difficulty of the last mile. It is the orthodox position, based on three arguments: first, the Phillips curve (which collects inflation data on the vertical axis and employment on the horizontal axis) is not linear, and becomes almost flat as inflation falls. The second, that inflation in services is tougher than that of consumer goods. And, three, if inflation expectations are anchored at levels above 2%, inflation will tend to rise to these levels.
According to a recent paper from the Atlanta Fed, there is not much evidence of this; The last mile is substantially different from the rest of the race, so it is not necessary for monetary policy to be different as well. “Believing that the last mile is more grueling could cause the Fed to tighten policy more than necessary, increasing the likelihood of a recession and a sharp rise in unemployment,” he notes.
The asymmetric approach is not free, because doing nothing is already doing something and, although the path of inflation seems appropriate, the same is not true of growth. Central banks have their ghost of Christmas past in entrenched inflation but, as in Dickens's tale, they can see the specter of a recession as the ghost of Christmas future.
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