The Last Mile

This article is based on the Homer Jones Memorial Lecture delivered at the Federal Reserve Bank of St. Louis, November 2, 2023.

Abstract

Headline inflation in the euro area declined rapidly to 2.9% in October 2023 from its peak of 10.6% one year earlier. The bulk of this large drop reflected the substantial decline in the contributions from energy and food inflation. Once these base effects reverse, continued disinflation relies critically on monetary policy succeeding in reducing underlying inflation in a steady and timely manner. The last mile is about this change in the disinflation process. Large uncertainty around the appropriate calibration and effective transmission of monetary policy, 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. In particular, monetary policy transmission may be weaker, or less direct, than in the past, given the share of less-interest-rate-sensitive services industries in total activity has increased steadily in the euro area and globally over the past few decades. In addition, persistent worker shortages have muted the transmission through the labor market, with unemployment at record low levels despite the sharp increase in interest rates. So, although progress on inflation so far is encouraging, the disinflation process during the last mile will be more uncertain, slower, and bumpier. Continued vigilance is therefore needed.

Introduction

In long-distance running, the last mile is often said to be the hardest. With the finish line within reach, one must push even harder to achieve the long-held goal. The same could be said about tackling the last mile of disinflation.

Throughout 2023, we have seen the first phase of disinflation. Headline inflation 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. These were the quick wins of the disinflation process.

Bringing inflation from here back to 2% in a timely manner may be more difficult: 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. 

Monetary policy needs to respond to these challenges with perseverance and vigilance.