The head of the European Central Bank said inflation has become more unpredictable due to shocks like the Covid pandemic and Russia’s invasion of Ukraine — and that policymakers need to take the possibility of such extreme scenarios into account and communicate them to the public.
“The world ahead is more uncertain, and that uncertainty is likely to make inflation more volatile,” ECB president Christine Lagarde said Monday in a speech opening the central bank’s annual conference in Sintra, Portugal. “It’s pretty basic, but that’s the reality.”
One reason, she said, was that increasingly frequent supply disruptions are leading companies to change their prices more often — a habit that goes beyond the recent burst of inflation in the U.S. and Europe, and “reflects a structural shift in how firms operate under conditions of permanently higher uncertainty.”
The bank’s assessment of the economy needs to rely on accounting for extreme possible scenarios, as well as more likely baseline predictions, and it should communicate those potential outcomes to the public, she said. Lagarde cited the inflation spike following Russia’s invasion of Ukraine as one example. A baseline scenario based on higher energy prices suggested inflation for 2022 would be 5.5%, but a worst-case scenario indicated inflation could top 7% — much closer to the final figure of 8%.
Another example was the pandemic, when spending by homebound consumers shifted from services like restaurants to goods such as home exercise equipment.
“Scenario analysis could have helped in illustrating that the range of possible inflation outcomes was unusually wide — and would have reduced the risk of projecting false certainty to the public,” Lagarde said.
The bank’s strategy review, announced Monday, reaffirmed its inflation target of 2%, a goal it has met for the time being, with annual price increases at 1.9% in May. The drop in inflation has allowed the bank to cut its benchmark interest rate from a peak of 4% to 2%.
Threats of higher tariffs from U.S. President Donald Trump have added to uncertainty about the outlook for growth and inflation. The European Commission and U.S. negotiators are trying to reach a trade agreement ahead of a July 9 deadline.
The conference in Sintra is the ECB’s equivalent of the U.S. Federal Reserve gathering in Jackson Hole, Wyo., and gathers top central bankers and economists from around the world. Fed Chair Jerome Powell is scheduled to take part in a panel on Tuesday with Lagarde, Bank of England governor Andrew Bailey, Bank of Korea governor Chang Yong Rhee and Kazuo Ueda, governor of the Bank of Japan.