Isabel Schnabel: The European Central Bank’s policy in the COVID19 crisis – a medium-term perspective Remarks by Ms Isabel Schnabel, Member of the Executive Board of the European Central Bank, at an online seminar hosted by the Florence School of Banking & Finance, Frankfurt am Main, 10 June 2020. * * * Accompanying slides of the speech. Over the past few weeks, hopes for a short duration of the COVID-19 pandemic and a quick rebound in economic activity have started to fade. Evidence is increasingly pointing towards a protracted impact of the crisis on both demand and supply conditions in the euro area and beyond. For central banks, this implies a shift in focus from economic “firefighting” – ensuring orderly market functioning and a sufficient provision of liquidity – to dealing with the implications of the crisis on medium-term inflation. My remarks today will focus on these implications. Based on our most recent Eurosystem staff projections, I will first discuss the risk of COVID-19 leaving a deep footprint on growth and inflation in the euro area. Against this background, I will then describe how we designed and calibrated our policy response, and explain why the pandemic emergency purchase programme (PEPP) remains the appropriate tool to address the current challenges of the crisis in the context of our price stability mandate. The medium-term economic impact of the crisis The immediate economic fallout from the COVID-19 pandemic has been substantial. In the first quarter of 2020, euro area GDP declined by 3.6%.
In the baseline scenario, ECB staff projections predict notable downward pressure on inflation arising from the much larger shortfall in aggregate demand than 1/7  BIS central bankers' speeches  supply. As a result, headline inflation is not anticipated to be back on its pre-COVID-19 path by 2022 in that scenario, and underlying inflation is also expected to remain subdued in the medium term (see right chart on Slide 2). Given the unprecedented impact of the crisis on income and consumption, such disinflationary effects are not surprising. But uncertainty around these forecasts is exceptionally large: while measuring economic slack is already a challenge in normal times, it is currently exacerbated by the highly uncertain effects of the crisis on potential output, both in the short and in the medium to long run. In the short run, potential output is severely affected by disruptions in global value chains and social distancing measures, which constrain the full use of capital. Think of the hairdresser who may only be able to use half of his or her physical capacity. Such effects may partly offset the negative effects of weakening demand on inflation even in the short run. In the medium to long run, the impact of the crisis on potential output, and hence on inflation, will crucially depend on the response of firms and policymakers to the challenges we are currently facing. First, some sectors of the economy may never return to their previous size, requiring a large reallocation of capital and labour, also across borders.