G. Stournaras: Careful attitude is needed until the Ukrainian issue is resolved

The pandemic, the energy crisis and now the Russian invasion of Ukraine are causing supply disruptions that intensify inflationary pressures, said the Governor of the Bank of Greece, Giannis Stournaras, stressing that the ECB will do “whatever it takes” to ensure price stability.

In particular, in his speech at the EUROFI 2022 High Level Seminar, organized in Paris in cooperation with the French Presidency of the Council of the EU, Mr. Stournaras spoke on the issue of normalization of monetary policy in the euro area.

Among other things, the Greek central banker stressed the need to be careful about when and how the Ukrainian crisis will be resolved, noted the impact on the energy crisis and estimated that inflation will remain higher for longer than expected but will fall to the 2% target levels.

The main points of Mr. Stournaras’s position are detailed:

“What we are seeing today is mostly supply-side inflation. To be precise, the acceleration of inflation mainly reflects two interrelated supply-side shocks:

One comes from the pandemic. In fact, we had a series of pandemic disturbances, then an energy crisis, and finally we have the Russian invasion of Ukraine, which, in terms of its economic impact, is also a supply-side disruption.

In the short run, its effects work in the direction of stagnant inflation, but in the medium term they lead to deflation, depending of course on the de-escalation of uncertainty. At present, we do not know when and how the Ukrainian crisis will be resolved, so we must take a careful stance.

These supply-side disruptions and disruptions that we are experiencing, combined with our supportive monetary and fiscal policies, have created conditions of excessive demand relative to supply.

This has happened not only in the euro area, but also in much of the world, including the US, which has adopted much larger-scale fiscal stimulus measures than we have. Excessive demand has pushed up prices for energy products such as oil and gas. Gas prices have also been greatly affected by Russia’s invasion of Ukraine and are likely to rise further in the future. This is why the aforementioned supply side disturbances are interrelated.

It is no coincidence that the rise in oil prices coincided with the pandemic. Of course, as we approach the end of the pandemic, supply chain problems will diminish – a process that has already begun. Combined with the gradual elimination of excess demand, the energy crisis is expected to escalate. However, the Ukrainian crisis and its resolution are likely to delay this development.

Given this situation, the macroeconomic projections of the ECB and the forecasts of all the major financial institutions that I know of indicate that consumer price inflation will converge to 2% over the next two years.

Inflation expectation indicators, such as the interest rate on inflation-linked swaps (ILS) after five years and over a five-year horizon, as well as the performance of the 10-year benchmark bond in the euro area, are in line with the medium-term our 2% inflation target.

Finally, so far there is no evidence of significant secondary effects on the labor market.

In summary, inflation will remain higher than we expected, but is expected to decline to levels consistent with our goal of price stability in the medium term.

As you know, monetary policy is not suitable for supply-side disruptions. It can do so, but at a high cost in terms of product and employment.

In my view, we have so far chosen the right path for monetary policy. Of course, in our next meetings we will continue to examine the available data, especially the economic and financial consequences of the Ukrainian crisis. If necessary, we will not hesitate to decide on the next steps to normalize monetary policy.

About the green transition you mentioned: This is one of the big megatrends we are seeing. At the same time, however, we are observing many other major trends, such as the digital transformation and the aging of the population. I have no doubt that, in the medium term, green energy will lead to lower energy prices compared to fossil fuels, but in the short term there is a transition cost, which is linked to the fact that we have not yet secured sufficient storage capacity for green energy.

That’s why we depend so much on gas.

As a result, in the short term the transition to green energy will cause a change in the relative prices, which will increase the general level of prices.

Let me first assure you that the Board will do “whatever it takes” to achieve our medium-term price target. Therefore, if we see that the outlook for inflation indicates that our target has been exceeded in the medium term, we will act accordingly in March or later. But we will definitely look carefully at the available data, because we do not want to repeat the mistakes of the past and make an early contractionary change in monetary policy, especially when we are faced with such a serious supply disruption as the one caused by the Ukrainian crisis.

Second, on reliability: After so many years of quantitative easing, medium-term inflation expectations are 2% or lower. At the same time, wage agreements in the euro area are consistent with our 2% inflation target, taking into account productivity growth. These suggest that the credibility of our monetary policy and our 2% inflation target is very high.

Third, on real interest rates: Central banks can only control nominal monetary quantities, not real ones. We must also not forget the real equilibrium interest rate, which is determined by market forces and in particular by the relationship between savings and investment.

Before the pandemic – I must remind you – we had agreed that the real equilibrium interest rate was zero or even negative. Has that changed? What are the fundamental forces that could have caused this change?

Personally, I am not at all sure that the deflationary trend that was recorded for a number of years in the euro area before the pandemic has now turned into an inflationary trend. As I mentioned above, the unexpected rise in inflation that has been observed recently is linked to supply-side disruptions.

Fourth, on the relationship between money supply growth and inflation: as we all know, this relationship is not stable and has been reversed in the past. Have you noticed e.g. Whereas, despite the very high increase in the money supply recently, inflation expectations remain stable below 2%; This is extremely important.

I must also tell you that I do not belong to the school of economic thought which completely ignores the money supply. I believe that the economy is governed by the forces of aggregate demand and aggregate supply, and that money is part of the forces of aggregate demand. However, under certain circumstances, the amount of money does not matter, in the sense that it can not affect economic variables.

Keynes, for example, had spoken of the “liquidity trap.” In addition, we know from various variants, old or new, of the Mundell-Fleming model, that under certain circumstances the amount of money does not matter. So let us not be dogmatic in either direction. There is no doubt that inflation in the long run is a monetary phenomenon, but “in the long run” can in practice mean a very long period of time!

Fifth, we must not forget that the contractionary change in monetary conditions in the eurozone will begin in June, with the possible repayments of TLTRO.

Finally, I want to assure you once again that we will do “whatever it takes” to ensure price stability. ”