2023 Homer Jones Memorial Lecture

Welcome to all of you to the St. Louis Fed and the 32nd, hard to believe, Homer Jones Memorial Lecture. For those of you I have not had a chance to meet yet, I am Kathy O'Neill Paese. I am the interim president of the Federal Reserve Bank of St. Louis and the chief operating officer, kind of wearing two hats at the same time right now but really having a good time with it.

So I wanted to talk a little bit about our lecture this evening. And the Homer Jones Memorial Lecture honors the memory and enduring contributions of the former St. Louis Fed research director. For those of you who either knew him, or have attended these lectures in the past, Homer's legacy is probably very well known. But every year, we always have a few new people, new faces in the crowd. And so it might be useful to provide a snapshot of who Homer was and why we honor him.

Homer Jones taught at Rutgers University in the early 1930s. Arthur Burns, who later chaired the Fed's Board of Governors in the 1970s, was also on the Rutgers faculty at the time. One of their students was a young man named Milton Friedman. Homer introduced Milton to the brand of economics taught at the University of Chicago and made it possible for him to go there for graduate studies.

As many of you know, Friedman helped found and import a branch of monetary economics called monetarism and eventually won the Nobel Prize in economics. Homer joined the St. Louis Fed as our research director in 1958 and was instrumental in starting the Bank's own monetarist tradition. As director of research, and under President Darryl Francis, Homer Jones built the St. Louis Fed into a powerhouse of monetary economics, data dissemination, and public education about monetary policy and what it can and can't accomplish.

Shortly after Homer Jones' death in 1986, several of his colleagues and friends and academic acquaintances here in the St. Louis community organized the first Homer Jones Memorial Lecture. And that was in 1987. And the lecture has continued because of the support of many local organizations and people over the years. And the St. Louis Fed is very proud to host this event every year.

To this day, thanks in no small measure to those who followed in the footsteps of Homer, the Bank remains a force in macroeconomic and monetary policy research, the dissemination of economic data through our internationally known FRED system, our database, and the economic education work that we do for teachers and others in the public domain through our Econ Lowdown online learning portal.

So let me turn now to this year's event. This year's speaker is Dr. Isabel Schnabel. Dr. Schnabel is a member of the European Central Bank's Executive Board. The Executive Board is part of the ECB's Governing Council, which is the ECB's highest decision-making body. It sets interest rates and conducts monetary policy. The ECB's governing structure is similar in many respects to the Federal Reserve System of our Board of Governors and of our regional banks.

Dr. Schnabel was appointed to the Executive Board in 2020. She is currently on leave from the University of Bonn, where she taught financial economics since 2015. Prior to that, she was a professor of financial economics at the University of Mainz, Mainz, thank you, from 2007 to 2015. I should have checked with you ahead of time on that. From 2014 to 2019, she was a member of the German Council of Economic Experts.

Dr. Schnabel received her Ph.D. in economics from the University of Mannheim in 2003. Her research interests include banking, banking stability and regulation, international finance, economic history, and financial law and economics. She has won numerous awards, including the 2018 Gustav Stolper Award. Dr. Schnabel has published several articles in first-rate academic journals, including Review of Financial Studies, the Journal of European Economic Association and the Journal of Economic History.

In the financial press, and among financial market participants and economists, there has been much discussion about the last mile. And I can assure you at the FOMC meeting this week, that was a topic on the minds of many of us. The discussion pertains to the challenges central banks like the Fed and the ECB face returning inflation to their target, which is the Fed and the ECB's case for 2%. This evening, Dr. Schnabel will discuss the last mile. Please join me in welcoming Dr. Isabel Schnabel.

[APPLAUSE]

Dear President O'Neill Paese, dear former President Jim Bullard. It's a great pleasure to deliver the prestigious Homer Jones Memorial Lecture. Looking at the list of previous speakers, I feel, at the same time, honored and humbled that you have chosen me to deliver this lecture today. Thank you also Kathy, for the very kind introductory words.

Today, I will speak about current challenges for monetary policy in the euro area. But even if some of the facts that I am going to show to you today are specific to the euro area, and the economic situation of the U.S. and the euro area certainly differ in some respects, I'm sure that some of the arguments that I'm going to present today resonate with U.S. monetary policy makers. And I'm very much looking forward also to the discussion in the Q&A where we may actually touch upon some of those issues.

So as Kathy mentioned, the title of my speech is "The Last Mile." In long distance running, the last mile is often said to be the hardest. With the finish within reach, one must push even harder in order to achieve the long held goal. And the same could be said about tackling the last mile of disinflation. So over the past 12 months, we have seen the first phase of disinflation. Headline inflation in the euro area fell rapidly and measurably as previous supply side shocks reversed. Dislocations in global supply chains were gradually resolved, and energy and food prices came off their peaks reached after Russia's invasion of Ukraine. So these were the quick wins of the disinflation process.

In my remarks today, I would like to discuss why bringing inflation from here back to 2% in a timely manner may be more difficult. I will argue that unlike during the first phase, disinflation during the last mile hinges critically on the appropriate calibration and effective transmission of monetary policy. Large uncertainty around these two factors together with the risk of new supply side shocks pulling inflation away from our target once again makes this part of the disinflation process the most difficult. And monetary policy needs to respond to these challenges with perseverance and vigilance.

Headline inflation in the euro area declined rapidly to now 2.9% in October from its peak of 10.6% one year earlier. As you can see on the left-hand side of my first slide, the bulk of this large drop reflects the substantial decline in the contributions from energy and food inflation. So these are the blue and the green bars in the chart. And to a large extent, these effects were to be expected also in their magnitude. They arise from the statistical observation that after a large price shock inflation usually slows measurably once the unusually large monthly price increases of the previous year start to drop out of the annual inflation rates. And these rather mechanical dynamics are known as base effects.

Oil and gas prices in particular have come down remarkably fast from the highs observed in the immediate aftermath of Russia's invasion of Ukraine as you can see on the right-hand side. Today, oil and gas prices are trading close to or below pre-invasion levels. Such outright price declines are rare. They're usually limited to highly volatile prices of commodities that are traded in international markets and for which the pass through to final consumer prices is typically large and, in many cases, imminent running directly through the energy component of the HICP, the Harmonized Consumer Price Index.

Following large commodity shocks, an initial rapid decline in headline inflation is therefore the norm rather than the exception. And this was also the case after the global financial crisis in 2008 and the financial turmoil in 2012. A recent IMF study that probably some of you have seen, shows that such initial strong base effects have often given rise to premature celebrations. That is, when inflation starts falling, it is tempting to conclude that it has been fought off successfully, and that it is a matter of when and not if inflation will fall back to target.

However, in about 90% of unresolved inflation episodes, inflation declined materially within the first three years after the initial shock, but then either plateaued at an elevated level or accelerated again. Base effects themselves may be one reason why this can happen. By definition they have a finite horizon. They often turn from being a source of disinflation to becoming a renewed headwind as they operate in both directions. They swing like a pendulum, meaning that disinflation is not necessarily a smooth process but can be a rather bumpy road. This also applies today as illustrated on the left-hand side of my next slide.

So our estimates at the ECB suggests that should energy prices over the coming month increase in line with their historical mean, energy is estimated to add nearly 1.9 percentage points to euro area headline inflation by July 2024. So these are the yellow bars in this chart. This primarily reflects the strong decline in oil and gas prices observed since November 2022. A rise in energy prices over and above the historical mean would further amplify such base effects. The extraordinarily sharp rise in food prices in 2022 and early 2023 depicted on the right-hand side of this slide implies that similar dynamics for headline inflation may occur at some point for the food component of the HICP.

The other reason causing inflation persistence is that underlying price pressures can prove much stickier than volatile commodity prices. Last year's energy price shock quickly turned into a broad-based price level shock. As firms passed most of their cost increases on to final consumer prices. As a result, core inflation, which excludes the direct effects of energy and food, increased strongly in the euro area reaching its peak of 5.8% in March 2023, significantly later than headline inflation. In October, it was still running at 4.2%.

The reversal of base effects, implies that continued disinflation will need to rely on a steady decline in underlying inflation. And the last mile is about this change in the disinflation process. It is no longer about mechanical price reversals, but about the conditions required for the indirect and second round effects of supply side shocks not to become entrenched in underlying inflation. And this is the task of monetary policy.

Our most recent ECB staff projections, which are shown on this slide, see both headline and core inflation declining towards 2% by the end of 2025. The projections highlight a key characteristic of the last mile. While it took a year to bring inflation from 10.6% to 2.9%, it is expected to take about twice as long to get from here back to 2%. In other words, the disinflation process is projected to slow significantly. Essentially, this has to do with the way that wages and prices are set.

Last year, firms revised their selling prices much more frequently than they usually do, with an exceptionally high share of firms expecting higher selling prices, the yellow lines in the left-hand side chart. They were doing this to protect their profit margins at a time of rapidly rising input costs. In the dragon of economists, this is referred to as state-dependent pricing, illustrated on the right-hand side. If prices are far away from their optimal level, firms are more likely to adjust them.

In many cases, firms even raise their selling prices beyond the increase in costs, bolstering unit profits. The yellow bars in the left-hand chart on this slide. This was possible because aggregate demand remained exceptionally resilient at a time of significant supply constraints, depicted on the right-hand side, with fiscal transfer shielding firms and households from the adverse income effects of the pandemic and the war in Ukraine. But, when input costs are falling, or when conditions are broadly stable, most firms behave differently. They then revise their prices more reluctantly, which makes underlying inflation stickier and disinflation slower.

In addition, wages are often set in a staggered way, affecting firms cost base only with a lag. In the euro area, wage growth has picked up sharply over the past year as employees are trying to make up for lost purchasing power. Our indicators, especially those tracking recently signed wage agreements, these are the red and the green lines on the left-hand side of this slide, point to continued strong wage growth at a time when inflation is already falling. These are the slow moving second round effects of the adverse supply side shocks that hit the euro area economy in previous years.

Meager productivity growth is putting additional pressure on firms unit labor costs, which have been rising sharply since the beginning of 2022, as you can see on the right-hand side. The distribution of price changes, which are shown on this slide, illustrates these rigidities. In September, around 45% of services prices weighted according to their share in the HICP basket were still increasing at a rate above 5%, with this share declining only very slowly. So this is the green area in the left-hand chart.

In the goods sector, which is shown on the right-hand side, the share of products seeing particularly strong price increases started to decline earlier. But even in this sector, still nearly 40% of products are currently rising at a rate above 5%. Given these rigidities, this inflation will slow down appreciably. For core inflation to evolve in line with ECB staff projections, two key conditions need to be met. One is that the growth in unit labor costs eventually falls back to levels that are broadly consistent with our 2% medium term inflation target.

The second is that firms will use their profit margins as a buffer to limit the pass through of the current strong wage increases to consumer prices. The last mile is about ensuring that these two conditions materialize in a timely manner. And that process faces two key challenges. The first is the appropriate calibration and transmission of monetary policy. And the second is the potential occurrence of new supply side shocks.

Disinflation during the last mile relies critically on monetary policy, succeeding in reducing underlying inflation in a steady and timely manner. During the first phase of disinflation, a determined policy response was mainly required to keep inflation expectations anchored, thereby reducing the macroeconomic costs associated with restoring price stability. During the last mile, the demand channel of monetary policy, whereby tighter policy slows economic activity, becomes critical when the long and variable lags are gradually drawing to a close.

As such, monetary policy needs to steer wage and price setting in a way that ensures that the two conditions on unit labor costs and profit margins are met. And this is particularly true in an environment in which the multi-year suspension of fiscal rules and the potential absence of a revised economic governance framework in the European Union risk leaving fiscal policy too expansionary for too long.

While economic growth in the euro area has been weak over the course of this year, considerable uncertainty about the lags and effects of monetary policy remains. A broad distinction can be drawn between the uncertainty around the appropriate calibration of monetary policy and the uncertainty regarding its transmission. Calibration uncertainty relates to the choice of the appropriate level of the policy rates and the period over which they need to remain at this level.

It is inherently difficult to estimate the degree of monetary tightening required to bring inflation back to 2% over a certain horizon. And this is especially relevant in the current context. There is considerable uncertainty about the impact of recent shocks on the supply capacity of the economy, and hence on the level of slack. For example, if recent shocks were to depress the level of potential output more persistently, the output gap could be smaller or even positive rather than negative as in the conventional estimates.

At the same time, digitalization, rapid progress in artificial intelligence, and ongoing efforts to accelerate the green transition could boost potential output growth. This is what financial markets seem to increasingly expect. Since early 2022, market-based estimates of the natural rate have increased measurably both in the euro area and in the United States as you can see on the left-hand side of this slide. Overall, therefore there is large uncertainty about how structural changes will affect activity in the euro area and globally, making the calibration of monetary policy more difficult.

Transmission uncertainty can amplify calibration uncertainty. That is even if policy is initially calibrated appropriately, it is unclear how fast and to what extent a given policy impulse is transmitted to activity prices and wages. The right-hand chart on this slide displays different model estimates of the impact of our monetary policy tightening on euro area GDP growth. And you can see that these estimates differ substantially. The pace and strength of transmission affect the optimal level and duration of policy.

The transmission of our past policy actions to bank lending conditions has been strong with the cost of borrowing rising sharply, as you can observe from the left-hand side of this slide. As a result, net credit flows have virtually come to a standstill for both firms and households. These are the blue diamonds on the right-hand side. With interest rates on time deposits rising, saving has also become more attractive, contributing to a rise in household savings ratio.

The transmission through capital markets has been more mixed. Until recently, risk premia in most segments remained exceptionally compressed. In the past, risk premia in both equity and corporate bond markets rose when the euro area composite Purchasing Managers' Index, the PMI, fell below the growth threshold of 50, as you can see from the black lines on this chart. This has not been the case this year however. Although economic sentiment deteriorated measurably, the risk premium has held firm. This is depicted by the yellow lines, and this shows that financial conditions were easier than usual.

In sovereign bond markets, term premia, that is the risk premium investors demand for bearing duration risk, have increased continuously and persistently in the euro area since we started removing policy accommodation in December 2021. So this is the blue line in the left-hand side chart. The current and expected future runoff of all our asset purchase programs has contributed to this development, in this illustrated on the right-hand side. However, the historically unusually low level of the term premium in the United States, the yellow line on the left-hand side, is likely to have also held back a return to higher levels in the euro area through arbitrage conditions.

The recent rise in global term premia has helped bring market-based financing conditions closer to those expected given the current level of the policy rates. Although as we have seen just recently, volatility remains large. Significant uncertainty also remains about how broad a policy transmission will be affected by two structural factors. The first relates to the services sector.

Monetary policy works predominantly by affecting the cost of capital. It is therefore natural that it has a stronger impact on more capital intensive activities, such as construction and manufacturing. However over the past few decades, the share of capital intensive industries in total activity has declined steadily in the euro area, this is the blue line on the left-hand side, and also globally. Today, market services account for more than half of gross value added. This is the yellow line.

In our most recent corporate telephone survey, which is shown on the right-hand side, three out of four firms in the services sector reported that the substantial change in financing conditions over the past 12 months had no impact on their business activity. These are the yellow bars. And an even larger share of services firms expect this to be the case also over the coming 12 months. Monetary policy transmission may therefore be weaker, or less direct than in the past, which may lengthen the disinflation process.

The second source of uncertainty concerns the persistent shortages of workers. Surveys continue to point to labor as a critical factor limiting production as illustrated on the left-hand side of this slide. Shortages remain near historic highs across sectors and especially so in the services sector, the yellow line. As a result, companies have responded to weakening economic activity by hanging on to their employees out of concern that they may be unable to find workers once demand picks up again.

So despite the strongest tightening in the history of the euro area by 450 basis points in little more than a year, the unemployment rate, the blue line on the right-hand side, fell to a new historic low in August, while the labor force the yellow line continued to increase throughout the first half of this year. It is unclear how long the transmission through the labor market will remain muted. It is reasonable to assume that the longer economic activity stagnates, the harder it will be for firms, most notably small and medium-sized firms, to hoard labor. And indeed we are seeing first signs that the labor market is softening and that demand for labor is slowing.

But the more slowly this process unfolds, and the weaker it is, the higher the risks that persistent labor market tightness will challenge the assumptions underlying the projected decline in core inflation. In particular, unit labor costs may grow more strongly than projected as labor hoarding continues to weigh on productivity growth. And labor shortages support favorable wage bargaining conditions at a time when workers are still trying to make up for their substantial losses in their purchasing power.

Higher unit labor costs in turn raise the risk that firms pass a larger part of their cost increases onto final consumer prices, which could lay the ground for wage price spiral. And this brings me to the second challenge facing monetary policy makers during the last mile. Because this inflation will slow down appreciably, there is a high risk of new shocks pulling inflation away from our target once again before it has been reached and of inflation expectations becoming unanchored. And this is especially relevant in the current geopolitical environment.

The tragic events in the Middle East triggered by the terrorist attack on Israel are a case in point. Oil and gas price futures rose noticeably adding to concerns over supply following the recent gas pipeline leak in the Baltic Sea. More generally, we have recently observed a rising sensitivity of energy prices to even remote risks, such as strikes at liquefied natural gas plants in Australia. Such shocks can visibly disrupt the disinflation process. Compared with the end of June, oil prices are up by 25% in euro terms. Since then, the energy contribution to the inflation momentum, defined as the annualized three-month on three-month percentage change and shown in light blue on the left-hand side chart, has increased measurably. As a result, while in July the inflation momentum was consistent with annual inflation of 2%, in October, it was 4.4%. These are the dark blue dots.

Other shocks are already on the horizon. This year's El Niño is expected to bring a month of extreme heat and rainfall to parts of the world, reinforcing the risks stemming from global warming. This is threatening to disrupt crop cycles and put further pressure on global food markets, as illustrated on the right-hand side. By delaying the return of inflation to 2%, such adverse supply side shocks pose larger than usual risks to medium term price stability, as they are more likely to trigger shifts in inflation expectations.

It is well known that people tend to pay little attention to inflation when it is low and stable. But the theory of rational inattention suggests that firms and households start paying attention when inflation is high, making price and wage setting more sensitive to new price shocks. This is especially true if such shocks concern salient goods, such as energy and food. Private sector participants are factoring in these risks. Although our determined monetary policy decisions have secured the broad anchoring of long-term inflation expectations, surveys and financial market prices continue to point to concerns that inflation may stay elevated.

For example, the distribution of longer term inflation expectations in our survey of professional forecasters while remaining broadly anchored around our target, has shifted visibly to the right compared with the periods before and during the pandemic, as you can see on the left-hand side chart. With risks to the inflation outlook being tilted to the upside, similarly risk premia in the swap market for inflation far into the future remain elevated. These are the red bars on the right-hand side.

In the light of all of this, and with this I would like to conclude. This inflation really does seem like a long distance race. When the runner enters the last mile, the hardest work begins. While the first phase of the race may have appeared easy, the last mile requires perseverance and vigilance. The same is true for our fight against inflation. Perseverance is needed to avoid declaring victory too early. With our current monetary policy stance, we expect inflation to return to our target by 2025.

The progress on inflation that we have seen so far is encouraging and in line with our projections. We therefore decided to leave our key policy rates unchanged as last week's monetary policy meeting. However, the disinflation process during the last mile will be more uncertain, slower and bumpier. Continued vigilance is therefore needed.

After a long period of high inflation, inflation expectations are fragile and renewed supply side shocks can destabilize them, threatening medium term price stability. This also means that we cannot close the door to further rate hikes. If we stay vigilant, we will be able to spot early on any risks to the inflation outlook that are materializing, just as the runner listens to the signals from her body. This means that we need to carefully monitor all incoming data and continuously verify whether they are consistent with the assumptions underlying our projections.

Data dependence ensures that our monetary policy is at all times calibrated in accordance with the circumstances that we are facing. The inflation target is now within reach, but let's celebrate only once we have truly tackled the last mile. Thank you very much.

[APPLAUSE]

Kathleen O'Neill Paese: Thank you so much, Isabel. We're going to do a little Q&A here. Thank you, that was very thought provoking and very timely for me in particular just coming out of FOMC this week. So I'm going to ask everybody to start thinking of your questions but I'm going to start with one. So I noticed you talked a lot about energy prices and oil in particular. In this country, oil prices seem to be flattening out. You're having a very different experience. So what's your forecast for energy prices and oil? And given the instability in the Middle East and what's happening in Ukraine, how are you thinking about that and how that could influence inflation in the European Union?

Isabel Schnabel: Yeah, that's an important question. Can you hear me well?

O'Neill Paese and Audience: Yes.

Schnabel: OK. So first of all, let me say we don't forecast oil prices. We do look at markets. I mean, of course, market participants will always tell you that futures are a terrible predictor of what's actually going to happen in the market but we're still using market data. And that's what many, many people do. I don't know whether the Fed has actually energy price forecast, but we don't.

But, I mean, you're perfectly right that energy prices for us play a very important role, in a somewhat different role from the U.S. due to the fact that we are, of course, a net importer of energy. And this is also why, for us the price, the energy price shock that we've seen had more severe consequences because it basically constituted a huge terms of trade shock. So really a loss in welfare that also then in the end has to be borne by someone, and then you have the distributional question of who that should be.

So in any case looking forward, so on maybe just briefly on the conflict in the Middle East, so our preliminary analysis at this point shows that given that Israel in the end is relatively small, as long as the conflict remains contained, the impact on energy prices should be relatively limited. If, of course, the conflict widened, and in particular if a country like Iran was involved, the situation could change quickly.

So in any case, this is one, I think I stressed that in the speech, this is one of the big risks that we need to look at. And as I said, I believe this is-- I mean, we all remember that when the first energy price shock came, I mean, there was this discussion whether we could just look through it at as it would, the textbook would normally say. And I think what is clear is that now in this final phase of the disinflation, it becomes even harder to look through due to the fact that inflation expectations are already fragile. So this is certainly something we need to look at very carefully.

O'Neill Paese: Excellent. Thank you. All right, what questions do you have? Yes, start down here and then we'll go in the back.

Audience Member 1: Dan Thornton. I agree very much with your premise that inflation is a wild card. If you look at the Great Inflation, in fact, what happened is it came down a lot three times before it came down for good. And that led me to believe that what I call it is an inflation is an extremely complicated dynamic process that basically no one understands. Which is the reason, in my opinion, it's the reason why inflation has been so incredibly difficult to predict.

But my question is, we have some things you mentioned that affect inflation. You mentioned that another process with supply chains, you mentioned global warming as a possibility and some other things. So my question is, what can monetary policy do about those things? How is that going to-- how is monetary policy going-- if those things happen, how is monetary policy going to bring the inflation rate down? I just don't understand.

Schnabel: Yeah, so these are excellent points. So let me first say, I think all central bankers have to acknowledge that we know less about inflation that we probably thought we would. And I think this is why I think we have to be humble, and we need to go beyond the models. The models are incredibly useful, but we need to go beyond the models in order to interpret what is happening in real time and then respond appropriately. So there are people who say that looking forward-- and that's what you mentioned, I actually share that view-- there could be more adverse supply side shocks down the road. And the question is, what can monetary policy do?

And I think one point I stressed-- and I think it's important. And it's not as visible maybe as other things, is that one thing that monetary policy managed to do in the presence of these huge shocks that we've been facing is to keep inflation expectations broadly anchored. And I really wouldn't underestimate that. I mean, this is hugely important. And I think if we hadn't achieved that, we would be in a very different world. And that of course, is also something that monetary policy will be able to do also going forward. And for this, we need to show to people that we are worth their trust. So we have to prove that we are credible, that we are determined, that we will stick to the target that we announced, and this will help us to also deal with such shocks going forward.

O'Neill Paese: Jim, and then we'll go to the back.

Audience Member 2: Jim Bullard, Purdue, DSP.

[LAUGHTER]

Audience Member 2: So you emphasized some labor market data and wages are often thought to be a key determinant of inflation in Europe, but it sure didn't look like the labor markets were easing up at all-- unemployment 100 basis points lower than the pre-pandemic level. And I think you said an all time low since the dawn of the European Monetary Union. So it really doesn't seem like the pressure from that channel is going away. So why is everybody so confident that inflation is going to come back to 2%?

Schnabel: So first on labor markets, I think if you look at the hard data, the hard data is very strong, continues to be very strong. We do see in the surveys that some of the indicators are weakening, in particular in some sectors. So for example, I mean, the construction sector has weakened quite a bit. And then if you look at the employment expectations for those sectors that have already suffered quite a bit, they are clearly going down. Also if you look at surveys, that is pretty clear that there's going to be some softening. And don't forget that the euro area economy is in a very different situation from the U.S. economy.

So economic growth has been quite weak this year. So I would say, we are not in a recession, and in any case not in a deep recession, but we are stagnating. You could say, compared to what we may have expected just a year ago. And if you consider the enormous size of the shock that the euro area has been facing, this is still pretty good, I would say. I mean, it's not that bad, but in any case. But the weakening is there. And so then of course, should play a role. And that is what should bring inflation down.

I showed you the data on bank lending, I think in the U.S., I haven't seen the most recent data but it has at some point it went up again. So lending in the euro area is very weak, so the net flows are basically zero. And eventually, I would say that has to show up in lower investment, consumption was weak anyway already. And so I do think that there is some transmission going on, which helps us, but then the question is, is that enough or not? And what I'm saying is that my baseline would be that this will work as we project, but I say let's be careful, and let's see whether the incoming data support that view or not.

O'Neill Paese: Ken.

Audience Member 3: My question is that while interest rates have a tremendous impact on controlling inflation, but it also can have a tremendous negative impact on certain wrongs of our society. A job loss, inability to grow, inability to buy, and all those things. So my question is, in your modeling do you take that into consideration before you make those kind of decisions that often negatively affect millions of people both in Europe and in America?

Schnabel: So thank you very much for that question. So let me first stress one point. So our mandate is somewhat different from the Fed's mandate. So we have a primary mandate, and the mandate is only price stability. So that is what we are supposed to look at. And the transmission of monetary policy basically works through the dampening of the growth of aggregate demand and therefore the weakening of the economy, if you want, is not a side effect, but this is the transmission channel through which monetary policy can bring inflation down.

So that said, there is-- one probably would need to qualify that a bit. So for example, the ECB has defined its inflation target as a medium term target. Which has to do with the lags of monetary policy, and it also has to do with the fact that it could happen that you have a shock, say an adverse supply side shock, which is truly temporary, which hits the economy, which then reverses and at the time when monetary policy would become effective, the shock is already gone. That is kind of what I mentioned before this classic... in such a case, it would not be worth it to weaken the economy but you would want to look through that shock because of course, you do not want to cause an unnecessary weakening of the economy.

And so this medium term perspective is one way to deal a bit with that, because there are cases. And I think we are now in a situation where... case where you need to weaken the economy in order to bring inflation down. You do not want to do that unnecessarily. And for the Fed, the trade offs, of course, are somewhat different because you have the dual mandate even though if inflation, of course, is far too high maybe then that also shifts the weights, but there are others to talk about that.

O'Neill Paese: I think we've got time for one or two. Go ahead.

Audience Member 4: I'm not mostly-- I'm not a macro economist, but I'm curious about all these things. I think there's some differences between Europe and the U.S. When I think about the macro economy, I think of the fiscal authority and the monetary authority like a fire truck with a driver at the front and driver in the rear, but they often have different objective functions. And I have the impression now with the very huge government debt we have that the Fed is doing the best that they can do to reduce inflation given the hugely expansionary fiscal policies. Is that less of a problem in Europe? I noticed that you skirted around talking about fiscal policy but you mentioned it in terms of the COVID policy and also reactions to some fuel prices.

Schnabel: Yeah. So thank you for that question. So I didn't focus on the relationship between fiscal and monetary policy in this speech, but I would certainly say that the interaction between the two is hugely important. And I think many countries are suffering from the same situation. So of course, we had-- the timing of the fiscal impulses was somewhat different. So of course in the U.S. you had a very big fiscal impulse already during the pandemic. In the euro area, the even bigger impulse happened after the energy price shock where the governments tried to buffer both firms and households from the quite dramatic consequences of this energy price increase.

So I think it's fair to say that also in the euro area, fiscal policy was quite expansionary. And if you read our monetary policy statement, there's always a paragraph on fiscal policy where we say that governments should be very cautious, that they should reverse the support measures relatively quickly, because if that is not happening, monetary policy may actually need to do more than we would normally do. Because we in the end, we take fiscal policy as an input into our analysis and then we need to respond. And of course, it can happen that fiscal policy actions interfere with our goal of fighting inflation, then that makes the situation quite complicated.

O'Neill Paese: Well, Isabel, we are at time. So I want to thank you again so much for coming such a long way and sharing your views on the last mile with us. Very informative. We do have a gift for you. I'm coming off mic here briefly. So of course, everyone who comes to the Fed has to get a FRED sweatshirt. So if it's not the right size, or a different color, you need...

Schnabel: Oh, I love this one.

O'Neill Paese: Yes, yes. And all over the world, you can have it.

Schnabel: So I love this. I mean, you probably know that I'm also responsible for statistics at the ECB. So one of the troubles that we are facing is that some people are telling us when they're looking for euro area data, they are not using our data portal, but they're using FRED.

O'Neill Paese: Yeah.

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Schnabel: So I love FRED. I don't love that they use FRED for euro area data so we're working on that. But you are our big idol on the data portal front. And so thank you very much for actually having built this, which I think is really the gold standard.

O'Neill Paese: Thank you. And many, many of the builders of FRED are in the audience, many of our economists, so thank you for coming. Thanks for sharing.

Schnabel: Such a pleasure.

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