Piero Cipollone, a member of the executive board of the European Central Bank, detailed on Wednesday 27 March how the euro area is navigating through persistent inflation and supply shocks towards an economic recovery, with inflation expected to stabilise at 2% by mid-2025. He also provided a clear message on monetary policy: if incoming data confirm the scenario foreseen in the March projections, the central bank stands ready to “swiftly dial back” its restrictive monetary policy stance, indicating the board is aligning towards a steady decrease in interest rates in 2024.
Demand and supply shocks
Cipollone the outlook in Brussels during an event organised by the House of the Euro and the Centre for European Reform. He argued that the euro area economy has weathered a succession of demand and supply shocks in recent years, leading to sustained high inflation. A notable consequence of these shocks was a negative terms-of-trade shock, largely due to the euro area’s dependency on imports. This phenomenon effectively acted as an external levy on euro area income, which initially manifested through reduced real wages for workers.
Highlighting the effectiveness of the ECB’s restrictive monetary policy combined with the reversal of negative supply shocks, Cipollone noted a broad-based decline in inflation rates. He emphasised the importance of keeping inflation expectations well anchored and deliberated on the future direction of monetary policy adjustments.
Wages and productivity
A key point of concern addressed by Cipollone was the potential misalignment between wage and productivity growth, and its impact on achieving the ECB’s medium-term inflation target of 2%.
He said that in a steady-state economy, wage increases should align with productivity growth and the inflation target to prevent unsustainable cost pressures. However, he acknowledged that the euro area is not yet in such a state, with real wages and productivity growth lagging behind pre-pandemic levels. Despite a 3.8% increase in employment levels, the share of labour in value added remains lower than pre-covid-19 levels, although profits are beginning to normalise.
Cipollone suggested that the ongoing reversal of negative supply shocks and normalisation of profits present an opportunity for a real wage catch-up, which is vital for the euro area’s economic recovery. This wage adjustment is seen as crucial for boosting private consumption, despite projections indicating that real wages may still fall short of levels justified by productivity growth since the pandemic outbreak.
Cipollone warned against the sustained underutilisation of resources if wages and domestic demand remain suppressed, which could lead to a downward adjustment in potential output. He advocated for a moderate wage growth over the medium term to ensure a sustained convergence of inflation to the target. Cipollone also cautioned against an overly narrow focus on short-term wage developments, highlighting the need for a recovery in wages to solidify the euro area’s fragile recovery.
Monetary policy adjustments
With supply shocks receding and risks to the inflation outlook appearing balanced, Cipollone expressed increased confidence in achieving a 2% inflation rate by mid-2025. He advocated for a cautious approach to normalising policy rates, considering the euro area’s prolonged economic stagnation, downside risks to the economic outlook, and tight credit conditions.
In concluding remarks, Cipollone indicated readiness to adjust the ECB’s restrictive monetary policy stance swiftly if upcoming data align with the March projections, emphasising the importance of forward-looking information in guiding policy decisions.