2002, No 2, and Beyer, A., Gaspar, V., Gerberding, C. and Issing, O. (2009), “Opting out of the Great Inflation: German monetary policy after the break down of Bretton Woods”, Working Paper Series, No 1020, ECB, March. 26. ECB staff estimates find that the change in market pricing of the short-to-medium term interest rates and in survey evidence of Eurosystem balance sheet expectations between December 2021 and the assumptions implied in the September 2022 ECB staff projections would on average subtract around 1 percentage point from annual real GDP growth each year until 2024 (i.e. annual real GDP growth is estimated to be reduced by around one percentage point on average in 2022, 2023 and 2024). Since the September 2022 ECB staff projections, tightening expectations have further increased, implying a further impact on GDP growth. The estimated impact refers to the average across a set of models used by the ECB for policy simulations, including the NAWM-II model (Coenen, G., Karadi, P., Schmidt, S. and Warne, A. (2018), “The New Area-Wide Model II: an extended version of the ECB’s micro-founded model for forecasting and policy analysis with a financial sector“, Working Paper Series, No 2200, ECB, November (revised December 2019)), the ECB-BASE model (Angelini, E., Bokan, N., Christoffel, K., Ciccarelli, M. and Zimic, S. (2019), “Introducing ECB-BASE: The blueprint of the new ECB semi-structural model for the euro area”, Working Paper Series, No 2315, ECB, September) and the MMR model (Mazelis, F., Motto, R. and Ristiniemi, A.
First, conducting monetary policy based on the view that potential is permanently lower – without clear evidence that this is the case – could prove self-fulfilling and costly. The evidence increasingly shows that destroying demand also affects supply. Research on recessions over the last fifty years has found that deep contractions – including those driven by monetary policy – lead to long-lasting effects on real GDP compared to the pre-contraction trend. [20] This suggests that current macroeconomic policies should be designed to avoid unnecessarily heightening the risk that the increasingly likely contraction in coming months becomes a severe and protracted one, which would scar the economy. This requires that energy and fiscal policies remain targeted and contribute to dampen inflationary pressures, helping to keep inflation expectations anchored while preserving productive capacity. But it also requires that monetary policy does not ignore the risks of overtightening. [21] If we were to compress demand in an excessive and persistent manner, we would face the risk of also pushing output permanently below trend, irrespective of whether the initial shocks were temporary or not (that is, even if a harsh policy reaction was unnecessary). And that could not be easily reversed by subsequent policy easing, not least because expansions do not rebuild supply nearly as much as contractions destroy it. [22] Second, even if we were to conclude that supply shocks will lower potential durably, we would still need to examine their effects on demand before deciding our policy stance.