Isabel Schnabel: Monetary policy in a world of overlapping shocks

Monetary policy in today's world is facing increasing challenges due to a series of overlapping shocks. These shocks have the potential to affect household and firm behaviour, inflation expectations, and ultimately, the persistence of inflation. In response, the European Central Bank (ECB) has adopted a more transparent monetary policy framework, which includes a clearer reaction function outlining the factors considered by the Governing Council when determining monetary policy.

This framework guidance is intended to foster public trust in the ECB's commitment to maintaining price stability.

In order to address the current inflationary pressures, the ECB has raised key interest rates by 50 basis points since June, lifting the deposit facility rate from 2% to 2.5%. This adjustment is part of the ECB's commitment to bringing inflation back to its 2% target over the medium term. The Governing Council's decisions have been well anticipated and have been effectively transmitted to financing conditions.

The framework guidance has been instrumental in reducing excess volatility and preventing the "hall of mirrors" problem, where market prices no longer reflect investors' assessment of the economic outlook but rather expectations of what the central bank will do.

This report will examine three key aspects of monetary policy in the face of these overlapping shocks. First, it will explore how the nature of the shock shapes the monetary policy response. Second, it will address the challenges arising from navigating multiple shocks simultaneously. Lastly, it will discuss how the inflation forecast and incoming data influence policy assessments.

By understanding these aspects, the report aims to shed light on how monetary policy responds to the current sequence of shocks and the implications for the economy.