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Europe’s monetary over-tightening trap

By Lucrezia Reichlin

25 Jul 2023 · 3 min read

informed Summary

  1. After a series of interest-rate hikes, headline inflation in the U.S. and the eurozone is finally starting to fall significantly.

LONDON – Headline inflation is falling fast in the United States and the eurozone, following a succession of sharp interest-rate hikes by the US Federal Reserve and the European Central Bank. But monetary policymakers on both sides of the Atlantic have made it clear that they are not done yet. Are they going to go too far?

Core inflation, which is still running at around 5% in the the US and the eurozone, remains a major cause for concern. Central bankers fear that, given a resilient labor market, high core inflation (which excludes food and energy prices) risks fueling a wage-price spiral and a de-anchoring of inflation expectations. As we learned in the 1970s, this could make inflation very difficult – and costly – to tame, with central banks facing the related challenge of regaining lost credibility.

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