Isabel Schnabel of the ECB outlines how the central bank adapts its monetary policy amid multiple shocks, focusing on inflation, framework guidance, and data assessment to maintain price stability.
Isabel Schnabel, a member of the ECB Executive Board, delivered a speech at the 8th Annual EC-EIB-ESM Capital Markets Seminar discussing the challenges of monetary policy in a world of overlapping shocks.
She highlighted that inflation has returned and is affecting daily life, with new shocks impacting the euro area after a post-pandemic recovery.
The ECB has adapted through increased transparency by outlining its reaction function, which considers inflation outlook, risks, underlying inflation dynamics, and monetary transmission. This framework, referred to as “framework guidance” by President Lagarde, aims to foster public trust and clarity.
Since June, the ECB has raised interest rates by 50 basis points, from 2% to 2.5%, to ensure inflation returns to the 2% target. These decisions have been well anticipated and smoothly transmitted to markets, reducing uncertainty and market volatility.
Monetary policy response depends on how shocks influence the projected inflation path. If a supply shock raises inflation above target, the ECB considers tightening policy, counteracting demand expansion caused by higher expected inflation.
In a complex environment with overlapping shocks—such as energy, geopolitical conflicts, AI expansion, trade disruptions, and fiscal policy—ECB staff assess the size, persistence, and transmission of each shock to inform policy decisions.
Focusing on underlying inflation, rather than headline inflation, helps the ECB achieve sustainable price stability. This approach accounts for forecast uncertainties and the risk of misinterpreting temporary shocks, especially energy price fluctuations.
Raising interest rates since June was deemed appropriate given the outlook, with projections indicating inflation will gradually decline but remain above 2% due to indirect and second-round effects of higher energy prices.
Incoming data on inflation expectations, demand resilience, and interest rate effects are continuously assessed to determine if the pass-through of shocks aligns with forecasts or requires policy adjustments.
The ECB emphasizes that, in a world of overlapping shocks, maintaining trust and price stability requires timely and calibrated policy responses to prevent temporary shocks from becoming persistent inflation.
For more details, visit the official ECB press release: ECB official announcement.
