Belgium Faces Inflation Challenges: ECB’s 2% Target in Jeopardy

Brussels, October 9, 2023: In 2022, inflation in the euro area reached an alarming 8.4%, a level unseen since the inception of the currency union in 1999. The pressing question arises: do economic actors still anticipate an inflation rate close to the European Central Bank’s (ECB) 2% target? Despite indications leaning towards affirmation, critical considerations emerge.

Background: The aftermath of the Covid-19 pandemic triggered an unprecedented surge in inflation in the euro area. Factors such as pent-up demand, persistent supply chain disruptions, and soaring food and energy prices following Russia’s invasion of Ukraine led to a record-high inflation of 10.7% in October 2022. Although it gradually receded to 5.3% in August 2023, it remains significantly above the ECB’s target of 2%. Responding to this, the ECB adjusted its monetary policy stance, transitioning from a accommodative approach to raising interest rates.

Importance of Inflation Expectations: The ECB, led by President Christine Lagarde, has closely monitored inflation expectations, acknowledging their pivotal role in maintaining price stability. When expectations align with the 2% target, it becomes easier for the ECB to fulfill its mission. This article delves into a detailed assessment of current inflation expectations and their implications for monetary policy.

Why Inflation Expectations Matter: Inflation expectations are vital for macroeconomic stability, as history has demonstrated. The experience of the United States in the 1960s and 1970s, with inflation soaring from 1% to over 10%, serves as a stark reminder. Failure to control “inflation psychology” led to entrenched expectations of high inflation. Correcting this required extraordinary measures and came at a significant economic cost. Inflation expectations influence the appropriate monetary policy stance and shape economic decisions of households and firms.

Challenges in Assessing Inflation Expectations: Measuring and interpreting inflation expectations present practical challenges for policymakers. There is no single measure of inflation expectations, with different agents having diverse perceptions. Short-term and long-term expectations provide varying insights. Assessing the anchoring of expectations to the target rate involves distinguishing between “level anchoring” and “shock anchoring.” Level anchoring refers to mooring expectations to the target rate, while shock anchoring considers the impact of transitory shocks.

Conclusion: While longer-term expectations seem broadly anchored at the ECB’s target rate, heightened scrutiny is warranted. Divergence from the ECB’s objective in economic agents’ expectations could jeopardize the credibility of monetary policy. As Belgium navigates these challenges, anchoring expectations to the 2% target remains critical for achieving and maintaining price stability.