(a) Which part of the production network is directly affected? Shocks affecting sectors of complementary goods or services located upstream of the production chain (or difficult to replace) have greater effects than for those located downstream and easily substitutable.
(b) The degree of price stickiness of the affected sector. Persistent shocks to sectors that rarely change their prices will cause more lasting costs than temporary shocks to sectors whose prices are very flexible in both directions.
c) Internal shocks versus external shocks. Shocks to imported goods without a domestic substitute have a stronger immediate impact, while subsequently the terms of trade effect can partially attenuate total inflationary pressures. Changes in internal relative prices (such as the carbon tax) redistribute purchasing power among domestic consumers.
d) The predictability of the effects (a regularly increasing carbon tax announced in advance will have more manageable effects than those of an unexpected one-off jump).
Central banks will need to invest in more granular models to analyse these shocks. In particular, the integration of climate-related (physical) risks, while still in its early stages, should feed into our assessment of risks to the inflation outlook. Since supply shocks are all different, one possible approach is to use scenarios to explore complex interactions or low-probability/high-impact events. These scenarios could be useful inputs for a risk-management approach to monetary policy. In times of high uncertainty, we will not always be able to identify all shocks in real time, so a risk-management approach would rely on the most costly scenarios.
Two messages regarding our arrival point
Concerning our arrival point, allow me to highlight two key messages.
- First, even if supply shocks can cause complicated trade-offs between production and inflation in the short term, they should not prevent us from reaching our inflation target, which creates the most favorable conditions for sustainable growth over time. the long term.
- Second, thecommitment to our inflation target is an effective strategy to strengthen the anticipation channel of monetary policyiii. In this respect, the symmetrical medium-term target of 2% that we set in 2021 has served us well in recent years. We must therefore refrain from changing this 2% level, but the appropriate degree of flexibility will be part of our strategy review next year. A symmetrical medium-term target of 2% does not strictly mean 2.0% all the time, some room for adjustment in time is probably preferable to a margin of adjustment in the space. Our medium-term horizon gives us sufficient flexibility to smooth the adjustment to shocks, while a target defined as an interval could weaken the anchoring of inflation expectations and be mistaken, wrongly, for a zone of inaction monetary policy iv.
I would now like to move from these long-term challenges to a remark on our current policy.
Our pragmatic gradualism is consistent with a progressively higher weight on projections – and a progressively lower weight on data inputs. This reflects the variability of uncertainty and risks over time. Data can be volatile, and there is a risk of overreaction to new information, particularly through the end of this year: therefore, “data-driven” in the current inflation environment does not mean “based on flash estimates”. That said, the June inflation figure for France released this morning at 2.5% after 2.6% in May is encouraging: disinflation is on track. With data surprises now lower and revisions to our diagnosis smaller than two years ago, we have gained in confidence in forecasts and have increased room for maneuver to ignore small bumps in the disinflation process.
Let me conclude with a metaphor. The 24 Hours of Le Mans car race was particularly difficult this year due to dangerous weather conditions and 10 cars retired due to mechanical failures. This underlines that the more uncertain the journey, the more reliable the vehicle must be. This also applies to monetary policy and central banks: in uncertain times, we need a reliable vehicle. We have the strength of our two pillars: independence and our price stability mandates. Rest assured that, in these uncertain times, the credibility of the Banque de France and the ECB, and the trust they inspire, will be firmly anchored in these two pillars.
iGarnier, (O.), From the great moderation to the great volatility of inflation2023
iiNussbaum, (B.), Peak globalization2010
iiiVilleroy de Galhau, Anatomy of a fall in inflation: from a successful first phase to the conditions for a controlled landing, speech at Paris-Dauphine University, March 28, 2024
ivLe Bihan, Marx, Matheron (2021) Inflation tolerance bands in a neo-Keynesian model, and Grosse-Steffen (2021) Anchoring inflation expectations: are the formulations of inflation targets important?
