Christine Lagarde: Setbacks and strides forward - structural shifts and monetary policy in the twenties
Speech by Ms Christine Lagarde, President of the European Central Bank, at the 2024 Michel Camdessus Central Banking Lecture, organised by the IMF, Washington DC, 20 September 2024.
The views expressed in this speech are those of the speaker and not the view of the BIS.
Central banks are public institutions with powerful tools, but the way these tools affect the economy is constantly changing. This uncertainty comes, in part, from the famous "long and variable" lags of monetary policy transmission. It typically takes 18 to 24 months for a change in interest rates to have its peak effect on the economy and inflation.
But there are also more fundamental issues that affect the transmission of monetary policy, which were identified by Federal Reserve Chairman Alan Greenspan 20 years ago. He wrote that:
"The economic world in which we function is best described by a structure whose parameters are continuously changing. The channels of monetary policy, consequently, are changing in tandem."
In other words, the effectiveness of monetary policy is intrinsically linked to the evolving structure of the economy. In recent years, uncertainty about policy transmission has been particularly acute.
We have faced the worst pandemic since the 1920s, the worst conflict in Europe since the 1940s, and the worst energy shock since the 1970s. These shocks have changed the structure of the economy and posed a challenge for how we assess the impact of monetary policy. This challenge was exacerbated by the fact that the pandemic caught us after a long period of anaemic growth, below-target inflation and low interest rates.
To manage this uncertainty, we introduced a three-pronged policy framework, focusing not only on forecast inflation but also on underlying inflation dynamics and the strength of transmission. This framework has been instrumental in helping us calibrate the rate path over the last phase of the hiking cycle, during the period when we held rates at their peak and, more recently, as we have started to make policy less restrictive.