ECB Member Philip Lane discusses the monetary policy response to inflation deviations and the interaction between exchange rates and monetary policy at the 15th exchange rate workshop.
Philip R. Lane, Member of the Executive Board of the ECB, delivered a keynote speech at the 15th workshop on exchange rates, co-organised by Banka Slovenije, Banca d’Italia, the Bank for International Settlements, the European Central Bank, and the Nationale Bank van België/Banque Nationale de Belgique.
The speech is divided into two parts. The first discusses the appropriate monetary policy response to deviations of inflation from the ECB’s symmetric two percent medium-term target. The second explores the analytical perspectives on the interplay between the exchange rate and monetary policy.
Regarding inflation deviations, the ECB’s strategy aims for a symmetric two percent inflation target over the medium term, considering negative and positive deviations as equally undesirable. Small, transitory deviations do not require a response, while large and persistent deviations do, through non-linear, forceful policy actions.
For mid-sized, somewhat persistent deviations, the origin of the deviation influences the response. Supply-driven shocks, such as energy price changes, may not warrant aggressive policy responses if they do not threaten medium-term inflation targets, as their effects can be self-correcting and sector-specific.
Policy decisions are made on a meeting-by-meeting basis, based on comprehensive analysis of inflation dynamics, wages, profit margins, and inflation expectations, especially under conditions of high uncertainty. The approach emphasizes the importance of anchoring medium-term inflation expectations to maintain symmetry in the inflation target.
The second part of the speech examines the interaction between exchange rates and monetary policy. The euro’s nominal and real effective exchange rates have shown no clear long-term trend, with notable appreciation since summer 2022 against the US dollar, Chinese renminbi, and Asian currencies.
Model-based analysis indicates that a 10% euro appreciation would lead to lower inflation for about three years, a GDP decline of approximately 1% over three years, and a reduction in exports and imports. The appreciation affects trade through higher export prices and lower import prices, influencing domestic demand and investment.
Financial conditions are also impacted by exchange rate movements. The ECB’s Macro-Finance Financial Conditions Index shows that euro appreciation tends to tighten financial conditions, with recent strengthening contributing to this effect.
Model simulations of surprise monetary policy easing demonstrate that lower interest rates lead to euro depreciation, improving trade competitiveness and boosting exports and imports. Holding the exchange rate constant in simulations shows that depreciation amplifies the impact of monetary policy on output and inflation, highlighting the exchange rate’s role in transmission mechanisms.
Overall, the ECB’s analytical framework considers multiple channels and factors to assess the macroeconomic effects of exchange rate movements and monetary policy decisions, emphasizing an integrated approach to economic and financial stability.
