Dancing on the edge of stagflation

The European Central Bank (ECB) is facing a dangerous trade-off between the control of supply-led inflation and the need to avoid a further recession in the euro area. The paper argues that an effective ECB monetary strategy to handle this trade-off would have been to anticipate the increase in the policy interest rates and to postpone the end of the asset net purchaseprogrammes. The ECB did not follow this sequence, which is why its current monetary policy, bound in a difficult balance, risks favouring a euro-area stagflation and financial market fragmentation. The new anti-fragmentation instrument (TPI) introduced by the ECB appears ineffective and subject to excessive discretion. The ECB should instead pursue a compelling combination of its rules- based monetary policy with EU centralised and national fiscal policies. This paper was provided by the Policy Department for Economic, Scientific, and Quality of Life Policies at the request of the Committee on Economic and Monetary Affairs (ECON) ahead of the Monetary Dialogue with the ECB President on 26 September 2022.