Monetary policy tightening to bring inflation down to target – Managing energy crisis takes key role
In autumn 2021 the euro area economy was picking up as the COVID-19 pandemic began to ease. Russia’s brutal attack on Ukraine in February 2022 necessitated a reordering of priorities in international politics. The Ukraine war and the energy crisis arising from it have darkened the economic outlook. “The energy crisis and swings in the economy are now affecting everyday life for all of us. Gas supplies have clearly been weaponised by Russia in an energy war. So the European Union must bring order to its ranks once again and resolve this energy crisis,” says Governor of the Bank of Finland Olli Rehn.
The adverse growth impact of the energy crisis is largely still to come.The euro area economy will be unable to rely on world trade to bolster it. Economic growth has slowed in both the United States and China, and this adversely affects the export outlook for the euro area. The prospect of a recession in the euro area has grown more likely.
Inflationary pressures gathered momentum over the summer as the energy crisis worsened in Europe. Natural gas and electricity in particular have risen sharply in price and there is an energy shortage too. Inflation in the euro area was 9.1% and in Finland 7.9%. in August. Higher energy and food prices have been major factors driving up inflation, but the prices of many other products and services have also risen this year.
While the ability of monetary policy to specifically influence energy prices is very limited, monetary policy measures are being deployed to respond to the surge in the general level of prices. “The key ECB interest rates were raised by half a percentage point in July and by a further 0.75 percentage points in September. The aim was to bring forward the transition from very low rates towards a level that will ensure inflation is brought down to our 2% target over the medium term,” explains Governor Rehn.
The surge in inflation has so far been reflected only moderately in wage trends within the euro area. To make sure inflation is brought down in the years ahead, it is essential to avoid an adverse wage-price spiral and to keep inflation expectations stable. “The task of monetary policy is to ensure that inflation expectations remain anchored and accord with the inflation target over the medium term,” says Rehn.
The energy crisis sets new challenges for public finances in the euro area. The long-term debt sustainability of more than one third of the countries in the euro area is under serious threat. “The efforts of EU countries to identify ways to limit household energy bills are understandable, but indiscriminately increasing expenditure would not be and would not help in the fight against inflation. It would instead be right to balance out the effects of the rise in prices through tailored, temporary measures targeted at the most vulnerable,” says Rehn.