Inflation has become more volatile and unpredictable due to shocks such as the COVID-19 pandemic and Russia's invasion of Ukraine. European Central Bank President Christine Lagarde emphasized the importance of scenario analysis in economic assessments, acknowledging the structural shifts in how firms operate during heightened uncertainty. Regular supply disruptions cause companies to alter pricing frequently, requiring policymakers to communicate a range of possible inflation outcomes to the public. The ECB maintains an inflation target of 2%, currently achieved with inflation at 1.9% in May.
"The world ahead is more uncertain, and that uncertainty is likely to make inflation more volatile," ECB President Christine Lagarde said Monday in a speech opening the central bank's annual conference in Sintra, Portugal. "It's pretty basic but that's the reality."
One reason, she said, was that increasingly regular supply disruptions were leading companies to change their prices more frequently, a habit that goes beyond the recent burst of inflation in the U.S. and Europe and "reflects a structural shift in how firms operate under conditions of permanently higher uncertainty."
Lagarde in particular cited the inflation spike that followed Russia's invasion of Ukraine, where a baseline scenario based on higher energy prices suggest inflation for 2022 of 5.5% - but a worst-case scenario indicated more than 7% inflation, much closer to the final figure of 8%.
"Scenario analysis could have helped in illustrating that the range of possible inflation outcomes was unusually wide - and would have reduced the risk of projecting false certainty to the public," Lagarde said.
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