Monetary policy in an era of supply headwinds – do the old principles still stand?

Speech by Ms Andréa M Maechler, Deputy General Manager, Bank for International Settlements, at the London School of Economics, London, 2 October 2024.

Adverse supply shocks have played a significant role in the post-pandemic inflation surge, when inflation rates in advanced economies reached levels not seen since the 1970s. The future is likely to bring more volatile inflation due to less elastic supply capacities and more frequent adverse supply shocks, necessitating a re-evaluation of monetary policy principles and frameworks. The traditional approach of "looking through" supply-driven inflation has been based on the transitory nature of such shocks and anchored inflation expectations. However, the recent inflation surge has revealed that risks of inflation de-anchoring can emerge suddenly, and forceful monetary tightening may be required to re-anchor expectations and stabilise inflation. Going forward, more frequent adverse supply shocks mean that central banks must exercise care when assessing if they can look through their inflationary effects. Circumstances may require central banks to lean more forcefully against inflation to contain the risk of transitioning to a high-inflation regime. Central banks will need to strengthen their analytical capability to assess the nature and transmission of supply shocks and how monetary policy should react to maintain trust in the purchasing power of money.