Closing the EU’s inflation governance gap: the limits of monetary policy and the case for a new policy framework for shockflation

This article assesses the adequacy of the European Union’s inflation governance framework in the context of frequent inflationary shocks. An inflation governance framework is the set of normative ideas and corresponding practices that govern the interpretation of objectives, the design of instruments, and how decision-making should proceed to prevent inflation. Within the inflation governance framework with which the EU approached the post-pandemic inflation, European policymakers expected that the ECB’s monetary policy would provide a sufficient safeguard for price stability. The framework was geared towards inflation that is demand driven: government spending and wage increases in excess of productivity. The post-pandemic shockflation in contrast, started with specific disruptions in systemically significant sectors and cost shocks which were propagated by firms’ pricing decisions. We argue that the framework’s over-reliance on the ECB and its narrow interpretation of its inflation-fighting role is no longer fit for purpose. Because monetary policy is not an adequate instrument for dealing with these supply-side drivers of inflation, the EU currently lacks adequate governance structures. We also set out the structure of a new inflation governance framework that targets shocks to systemically significant prices directly, before they are propagated through the economy.