ECB President Lagarde on Inflation Volatility

FRANKFURT (Reuters) – Profound shifts in the world economy could make inflation volatile for years to come, complicating efforts to control prices. However, European Central Bank President Christine Lagarde stated that adhering to inflation-targeting regimes remains the best strategy.

Economic shifts towards deglobalisation and protectionism, alongside advancements in technology, have baffled economists over the past decade. Many failed to foresee the recent inflation surge, causing central banks to lag behind in price control efforts.

Lagarde, who took charge of the ECB just months before the COVID-19 pandemic, emphasized the need for flexibility amidst increased uncertainty. “If we enter an era where inflation is more volatile and monetary policy transmission is more uncertain, maintaining this deep anchor for price formation will be essential,” she stated at an IMF event in Washington. She noted that this does not mean monetary policy will remain the same.

A significant change is the rise of “superstar” firms in the digital economy, such as cloud services and e-commerce. These massive firms rely less on external financing and have a reduced labor share, making them less responsive to interest rate fluctuations and decreasing central banks’ influence over the economy.

Conversely, a return to globalisation can enhance central banks’ effectiveness if firms opt for “nearshoring” or “friendshoring,” thus increasing capital requirements and their sensitivity to interest rates. Lagarde remarked, “Capital deepening could increase the economy’s sensitivity to interest rate changes, potentially enhancing the effectiveness of monetary transmission through the interest rate channel.”

However, these adjustments may also lead to greater inflation volatility, especially if tech giants become less responsive to monetary policy while manufacturers face more impact.

Moreover, the rise of fintech firms in lending poses additional challenges for central banks. While they provide efficient credit expansion, fintechs are more sensitive to environmental changes, which could amplify economic booms and busts. Lagarde cautioned that this responsiveness means fintech lending might be more procyclical, intensifying credit cycles and volatility during stress.