Excerpts from the speech by Mario Draghi, President of the ECB, The ECB and Its Watchers XIX Conference organised by the Institute for Monetary and Financial Stability, Frankfurt, 14 March 2018:
In this environment, policymakers have to be more cautious than in the past about the assumptions that underpin our forecasts – and simple policy rules based around estimates of the output gap are no longer a useful guide for our actions. The severity of the crisis means that we cannot rely exclusively on traditional historical relationships to determine how quickly real developments will be passed through into nominal ones.
The key issues we need to examine are wage dynamics, their pass-through to prices, and the possible risks to the inflation outlook.
Wage growth has been trending upwards for the euro area as a whole, rising by 0.5 percentage points from the trough in mid-2016. But consistent with the weakening of the relationship between slack and inflation, the adjustment of wages during the recovery has so far been atypically slow.
So this is an issue we will have to monitor closely, especially in an environment where one has to be cautious about extrapolating past relationships into the future. To build confidence that inflation dynamics are on track, we will need to see the actual data improving over time, which means stronger evidence of both strengthening wage growth and wage growth translating into ULC growth.
Moreover, there are still two risks to the outlook that could – if they intensify – conspire to reduce our confidence in the inflation path.
The first risk relates to the global environment, and in particular the possible spillovers of the new trade measures announced by the US administration.
Our own internal estimates suggest that the first-round effect on the euro area of the proposed measures is likely to be small, even if there is symmetric retaliation from US trading partners. But there are potential second-round effects that could have much more serious consequences. These include the risk of retaliation across other goods and an escalation of trade tensions; and the potential for negative confidence effects, which would weigh on business investment in particular.
The second risk relates to developments in foreign exchange markets and wider financial markets.
The euro has appreciated since the beginning of last year, and according to our analysis, this has recently been driven more by exogenous factors – that is, purchases of euros that cannot be explained solely by the economic expansion. This might weigh on inflation down the line as it does not fully arise from stronger euro area fundamentals. So this is a development we need to monitor closely.