Lagarde: Energy shock demands careful policy calibration
ECB President Christine Lagarde addressed the enduring energy shock, outlining its profound economic consequences and the complexities it presents for both monetary and fiscal policy. She spoke at the 75th anniversary of the Association of German Banks in Berlin.
Europe's uncertain economic path
Europe faces unprecedented uncertainty, marked by a relentless sequence of shocks: a pandemic, a land war, the worst energy crisis in 50 years, and sweeping tariff increases.
The latest military conflict in the Strait of Hormuz has created the largest oil supply disruption in history, with an estimated net loss of 13 million barrels per day, or 13% of global consumption.
While current energy prices haven't yet pushed the economy into the ECB's adverse scenario, the outlook remains fragile.
Prolonged disruption risks broader effects, impacting critical inputs like helium for semiconductors, fertilizers for food prices, and methanol for chemicals.
A shift from price adjustments to rationing would directly hit output, worsening growth.
Policy calibration in a fog
Monetary policy faces a challenging environment due to two critical uncertainties: the duration of the energy disruption and the pass-through of energy prices to broader inflation.
The longer the conflict persists, the worse the economic outlook becomes, with non-linear effects.
Unlike 2022, when the shock's persistence was clear, today's range of outcomes is far wider.
Pass-through is influenced by households' fresh 'muscle memory' of inflation, potentially increasing sensitivity to rising costs.
However, higher energy prices and weaker consumer sentiment could dampen demand, limiting price and wage increases.
Fiscal policy's tightrope walk
Fiscal policy faces a critical challenge in cushioning energy shocks without exacerbating inflation or straining public finances.
Broad price-based measures, though lowering headline inflation, risk removing vital incentives for energy conservation.
Therefore, support must be temporary, targeted, and preserve price signals to effectively protect the most vulnerable.