Working Paper: CEPR ID: DP18375
Authors: Ricardo Reis
Abstract: A central bank that faces inflation above target may fail to bring it down. This article discusses six ways in which this happens because the central bank is dominated by: misjudgment, expectations, fiscal policy, financial markets, recession fears, or external forces. It applies this approach to the challenge facing the ECB in 2023-24. The hope is that the factors identified can serve as warning signs for what to avoid.
Keywords: monetary policy; interest rates; central bank independence
JEL Codes: E58; E50; E31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Underestimation of the real private rate of return (H43) | Nominal interest rates set too low (E43) |
| Nominal interest rates set too low (E43) | Failure to curb inflation effectively (E31) |
| Clinging to outdated theories (B52) | Policies that are too loose (E64) |
| Policies that are too loose (E64) | Allowing inflation to persist (E31) |
| Expectations of high inflation based on past experiences (E31) | Self-fulfilling prophecy of inflation (E31) |
| High debt levels (F34) | Pressure on the government to influence the ECB to maintain lower interest rates (E52) |
| Pressure on the government to influence the ECB to maintain lower interest rates (E52) | ECB maintains lower interest rates (E52) |
| Financial market influence (G19) | ECB hesitates to raise rates (E52) |
| International economic pressures (F69) | ECB acts contrary to its inflation targets (E52) |