Central Banks May Encounter Years of Volatile Inflation, Says ECB’s Lagarde

FRANKFURT (Reuters) – Significant changes in the global economy could lead to heightened inflation volatility for years, making price control efforts more challenging. However, European Central Bank President Christine Lagarde emphasized that adhering to inflation-targeting strategies remains the most effective approach.

In the last decade, economic transformations driven by deglobalisation, protectionism, and rapid technological advancements have perplexed economists. Many failed to anticipate the recent inflation surge, resulting in central banks scrambling to manage rising prices.

Taking the helm of the ECB shortly before the COVID-19 pandemic, Lagarde noted that an uncertain future lies ahead, advocating for greater flexibility instead of new mandates.

"If we enter a phase where inflation is more volatile and the transmission of monetary policy is more unpredictable, it will be crucial to maintain a strong anchor for price formation," she stated during an IMF event in Washington. "This, however, does not mean our approach to monetary policy will remain unchanged."

A significant factor influencing this landscape is the emergence of "superstar" firms in the digital economy, such as those in cloud services, e-commerce, online search, and potentially artificial intelligence. These large companies tend to rely less on external financing and have a smaller labor share, making them less responsive to interest rate fluctuations and challenging a central bank’s capacity to influence the economy.

Lagarde suggested that a reversal of globalisation could, in fact, strengthen central banks if companies choose to localize their supply chains through strategies like "nearshoring" or "friendshoring." Such moves would likely increase capital requirements for these firms, potentially making them more responsive to interest rate changes.

"Greater capital depth might enhance the economy’s sensitivity to interest rate adjustments, possibly improving monetary policy transmission through interest rates," Lagarde explained.

However, these developments could also lead to increased inflation volatility, especially if dominant tech companies are insulated from monetary policy while manufacturers feel its impact more acutely.

Additionally, the rising influence of fintech companies in lending poses further challenges for central banks. These firms are more adept at extending credit but tend to be more susceptible to environmental shifts, which can intensify economic cycles.

"This heightened sensitivity implies that fintech lending could become increasingly procyclical during periods of stress, exacerbating credit cycles and volatility," Lagarde remarked.