20221220_What high inflation means and how we are tackling it.txt

 We decided to raise interest rates today and expect to raise them significantly further because inflation remains far too high and is projected to stay above our target for too long. Speaking at our latest monetary policy press conference, the Government Council had just decided to raise interest rates in the euro area, our fourth rate hike since July 2022. We've been raising rates at the fastest pace in the Eurozone's history in order to fight inflation, which is currently well above our target of 2% in the medium term. Before this latest decision was taken, I sat down with my colleague Eva Taylor, who's a press officer here at the ECB. We talked about what is causing these rising prices, how they're affecting people in Europe, and what we at the ECB are doing to bring inflation back down. Eva, it's a pleasure to welcome you here on the ECB podcast to talk about what is a very important topic. It's a pleasure to be here. Now, 2022 has been a very challenging year for Europeans just as we were emerging from the pandemic, war erupted on our border and all this has caused prices to rise with inflation currently far too high in the euro area. Eva let's talk first about the impact that this higher inflation is having on people. How is it affecting Europeans? The higher prices are actually a strain for everyone right now and that is because the money in our pockets is losing purchasing power. What does that mean? That means that we can buy less with the money that we have over a certain period. And we feel it every day when we go out for dinner, when we go out for a coffee, when we do our weekly grocery shops, and we can feel it particularly when we get the energy bill at the end of the month. Yeah, it's kind of in the background every single day, right? every time we go out, every time we buy something. How about businesses? what's the impact of higher inflation on them? How are they seeing it? When inflation is high, it means that the economy cannot run as smoothly as it would otherwise. It also means that higher prices create a lot of uncertainty for business. So let's take, for example, a flower shop that wants to expand and the owner then calculates how much it would cost to build a new greenhouse and whether selling more flowers would then recover the costs. But when there is a risk that prices will increase that calculation is a lot more uncertain and that owner then may decide not to build that greenhouse and not building that greenhouse means that these jobs that would have been created will not be created, income will not be generated. Okay so this uncertainty is kind of holding people and especially businesses back from making decisions about the future from investing and that obviously then has a knock-on effect on the economy. Now one aspect our President Christine Lagarde has been very vocal about is how high inflation affects different people with different incomes in in different ways. Can you explain in a little bit more detail what exactly we're we're seeing there? Yes that's absolutely right. There are two aspects. So first of all high inflation really hurts those with low incomes the hardest and and that is because low-income households spend a larger share of their income on food and energy than households that are better off and on top of that they also have less of an opportunity to trade down and that means to choose a cheaper version of a product but they can't do that because probably they would have done that from the start anyway. And the food and energy part is important because there we've seen a lot of the rising prices, so that's where people are hardest hit I'd say in their shopping. Exactly. The second element here is that inflation is also really bad for those who depend on incomes that are fixed, like wages or support payments from the government. And when you have to pay these higher prices from a fixed amount of money, then that's a lot harder in the current circumstances. And it means that these people who are dependent on these incomes basically have to spend less until these payments catch up. Because it takes a little bit of a while for these payments to catch up. Exactly and during that time they're just poorer. Let's take a step back and look at what's behind the inflation itself. So what's behind this high inflation that we're seeing at the moment? What exactly is causing prices to rise? You already mentioned something about food and energy being a big part of it, but can we a little bit more detail there? Yeah, of course there are many reasons why inflation has gone up over the past year, so significantly, but there are two main courses and one of the main courses is the pandemic, of course. During the pandemic when we were in lockdowns and when we had social restrictions, it was a lot harder to move goods across borders and that meant that certain products were just not available and that drove up the prices for these products. And the supply bottlenecks that we've seen everywhere? Exactly, exactly and then once these social restrictions were lifted and the economy reopened people were very keen like you and me were very keen to go out again, to travel, to go to restaurants. And that pushed up prices, pushed up demand and thereby prices for all these services. And for air travel, for example, or for rental cars, when you go on holiday, you want to rent a car, so on and so forth. And businesses were just not able to adapt to this change in behavior quickly enough. And that meant there was a lot of demands, strong demands, still constrained supply, and that just drove up prices. The second point that drove up prices last year was Russia's invasion of Ukraine, the war in Ukraine, which meant that the deliveries of energy of oil and gas in particular were disrupted, and that drove up energy prices. And as I just said, and you said it as well, it's food and energy prices that are the key main drivers in the euro area of inflation in the euro area. Okay, so quite a few different factors there that have been pushing inflation up over the past year. Now, our mandate as a central bank is indeed to keep prices stable. But it does sound like a lot of these reasons we've just talked about are things that we as a central bank have no control over. I mean, things like oil and gas supplies and, well, even war. And that makes this a very hard job to deliver on at the moment. So, Eva, what exactly can we do? Yeah, that's a very good question. And you're right. So central banks can fight inflation, but central banks cannot stop a war. Central banks cannot provide cheap energy. And central banks can also not make transportation cheaper. We can make sure that inflation does not get out of control. And we can make sure that inflation does not get out of control and we can make sure that inflation does not become a permanent part of our life. That's our job, that's our mandate and we the ECB, we will do everything that is necessary, everything within our power to bring inflation back down and our goal is to bring inflation down to 2% and that is the approximate rate at which we think the economy runs best. Okay and the best way we can stop prices from rising is to put up interest rates and we've actually done that multiple times now as I mentioned in the introduction. Let's talk a bit about what those higher rates mean in practice for people and for businesses. Can you go into a little bit of detail there? Of course. So higher interest rates generally make it more expensive to borrow money and they influence how people spend, save, invest or borrow. And we can, let's take an example, let's look at house prices. So since interest rates have gone up, in fact, even a little bit before that already, mortgages have gone up, so the price of borrowing money to buy a house has gone up, it's become more expensive. And that means that many people who were thinking about a house may now think twice, may not decide to do that because it's become too expensive for them or they find it to risky because they're not sure whether they can afford that mortgage in future. So that means demand for houses goes down and that then has a knock-on effect on prices and prices may stop rising, house prices may stop rising. And then there is also the impact that higher interest rates have on companies. So companies who plan ahead, who want to expand, may now think more carefully about which project they want to engage in, because it has become more expensive to borrow money to fund these projects, and that then obviously also has an impact on the economic activity in general. Okay, so like for example, let's look at the the the flower shop we talked about earlier maybe they would have had a loan for two new greenhouses but now they can only afford a loan for one new greenhouse so because the interest rate has gone up and they're not sure if they can afford then to pay back that loan. Exactly so they may play it safe and say we definitely feel that we can do this and they only go for the smaller option. But then there's also the aspect that higher interest rates also mean that you get a lot more on your deposits so banks pay more on a savings account. So you may want to decide that you spend less and you're safe more. So when you do that demand goes down or when more than you, when everybody does that, or many people do that, demand goes down. And in an environment where demand goes down, it is a lot more difficult for companies to raise prices. Now, all these adjustments that we've just discussed, the impact of higher interest rates, all that takes time and it won't happen immediately. Inflation won't come down immediately but what will happen immediately is that the inflation expectation of people and businesses will be affected. Okay so it's all about reducing the demand, chasing all these goods and services that we've got in the economy at the moment. Now I want to zoom in on something you just mentioned and that's this this idea of inflation expectations which we hear central bankers talking a lot about and we read about expectations in the news a lot. What is behind this and why do people's expectations about inflation matter so much? Yeah, that's a good question. So I'd say if everybody would expect that prices will go up and up and up in future, then that will change how people and businesses behave. So it will for example mean that workers will then ask for higher wages to make up for the higher costs, for the higher prices. Companies then, who will have to pay these higher wages, then also increase their prices further. And that is a very bad spiral. And central banks can break that spiral and they can do that by raising interest rates. And by doing that, they send a signal. The center bank sends the signal that's and says that we will not tolerate ever higher prices. And we're determined to bring inflation back down as soon as possible. That's a signal the center bank sends, and that's a very powerful signal in fact because it guides then the expectation of people and businesses about the inflation to be expected in future and that to a certain degree also provides some certainty for their planning. Okay, that's clear. Thank you for explaining that. Now, typically the central banks raise rates to stop the economy from overheating that that's clear. Thank you for explaining that. Now, typically the central banks raise rates to stop the economy from overheating that that's what we've been talking about, kind of pushing down this whole demand that's there. This time though, the reasons behind high inflation are quite different. I mean, we have a war. That's something we haven't seen, fortunately, in Europe for quite some time now. But this difference means that our economy is actually struggling at the same time that we're raising interest rates. Are we not hurting people? So how interest rates or higher interest rates affect the economy also depends on their level? And when our governing council started raising interest rates back in July, interest rates were actually at very low levels and they were in fact partly negative. So since then the governing council has raised interest rates multiple times, and depending on how inflation is expected to evolve in future, the governing council may have to raise interest rates to levels that do hurt economic growth and employment. But the alternative scenario would be a lot worse. The alternative scenario of letting inflation rise and prices going up and up and not raising interest rates without anyone interfering, that would cause a lot more pain. And it would mean that our wages, the purchasing power for our wages, would be eroded and it has the potential to divide our society and if eventually, potentially also to undermine our democratic institutions. Okay, so very clear that we need to act in face of this high inflation. Iva, thank you so much for taking the time to explain what we're doing here at the ECB to fight inflation. Before you leave, I do have one question, one last question that we ask all our guests on the podcast. It's something of a feature. We always ask for a hot tip linked to the topic that we've discussed today. Do you have a tip for our listeners? Of course I do. I would like to recommend the new book by John Hilsenroth on Janet Yellen. Janet Yellen is the US Treasury Secretary and used to be the chairwoman of the Federal Reserve the Central Bank of the United States. And the book is called Yellen, the Trailblazing economist, who navigated an era of upheaval. And I like it because not only is it well written, John Hilsen-Rath is a senior writer at the Wall Street Journal, but it also tells the economic story of the past decades with all its crisis through the perspective of one of the most influential female policy makers. And I also like it because Janet Yellen is someone who never forgets that behind all the data that policy makers that policy influential female policy makers. And I also like it because Janet Yellen is someone who never forgets that behind all the data that policy makers look at day in day out. There are real people. And that is something that I feel is more important than ever right now. Absolutely. Okay, so John Hillsenroth on Janet Yellen. A really nice hot tip because Secretary Yellen has actually been on this podcast before together with President Lagarde and Commission President von der Leyen. So brilliant. Thank you so much Eva. Thank you. Well that brings us to the end of this episode. I want to thank Eva Taylor, press officer here at the ECB, for breaking down this really important issue for us. Be sure to check out the show notes for additional material on this topic. You've been listening to the ECB podcast with Katie Ranger. If you like what you've heard please subscribe and leave us a review. Until next time, thanks for listening.