 Hello, and welcome to the European Central Bank's eighth annual forum on central banking. My name is Claire Jones. I'm a journalist for the Financial Times, and I'm going to be your moderator. We're in the midst of an economic revival, but it's a revival of sorts. Unemployment might have fallen from its peak, yet it still remains higher than before the pandemic, especially for younger workers. The economy has yet to fully regain the ground lost during the early months of the pandemic, and the outlook for inflation is acutely uncertain. Climate change is a mounting threat. Despite the progress the EU has made in putting shots in people's arms, the eurozone is yet to fully reopen. We are, after all, hosting this event in Frankfurt, and not the somewhat sunnier climes of Cintra. In other parts of the world, billions remain unvaccinated. Over the course of the next two days, we'll look at how deep the scars of the pandemic go, and ask, how can we adjust? Earlier this year, the European Central Bank launched its first strategy review since 2003. Addressing the review's findings alongside how to conduct monetary policy in the post-pandemic economy will be at the heart of the sessions we're going to show you today and tomorrow. We're going to start with one of the highlights, a keynote speech from President of the European Central Bank, Christine Lagarde. Madame Lagarde, the floor is yours. Thank you very much, Claire. The economy is back from the brink, but not completely out of the woods. After a highly unusual recession, the euro area is going through a highly atypical recovery. This atypical recovery is leading to rapid growth, but also to supply bottlenecks appearing unusually early in the economic cycle. It is also causing inflation to rebound quickly as the economy reopens. And it is helping to accelerate pre-existing trends and new structural changes brought about by the pandemic, which could have implications for future inflation dynamics. So it's important to take a step back here, to understand how monetary policy should operate in this environment. We need to recognize where we have come from and where current trends suggest we are going. As John Maynard Keynes wrote, policymaker must always study the present in light of the past for the purposes of the future. End of quote. We are coming from a decade of strong disinflationary forces that have depressed the whole inflation process. And while the robust recovery is supporting underlying inflation trends, what we are seeing now is mostly a phase of temporary inflation linked to reopening. Structural changes could create both upward and downward pressures on prices. So we will need an accommodative monetary policy stance to exit the pandemic safely and bring inflation sustainably back to 2%. So in my remark, I would like to first of all have us remember where we came from and where we are before exploring the path of the future. In the decade before the pandemic, inflation across advanced economies consistently surprised on the downside. The inflation process appeared to have slowed down along the transmission chain, from activity and employment to wages, and then from wages to prices. And this was largely down to three factors. First, gouging the true level of slack in the economy became harder. Estimates of structural unemployment were consistently revised down as the economy strengthened. And even as unemployment came down, many more people were drawn into the labor market, especially women and senior people. Second, structural changes in labor market meant that receding slack fed more slowly into wage growth. Employment increased rapidly after 2013, but was mainly channeled into lower paying jobs. In parallel, global forces such as globalization and automation reduced workers' bargaining power. Third, when wage growth did eventually pick up, firms were reluctant to pass on cost increases to consumers. And instead, we saw firms squeeze their profit margins. This also reflected broader structural trends, such as the digitalization of services and the expansion of e-commerce. Then the pandemic hit, which led to a highly unusual recession, followed as I said, by a highly atypical recovery. In conventional business cycles, the depth of the slump normally determines the pace of the recovery. After exceptionally deep recessions, both demand and supply are often impaired for many years. From the onset of the great financial crisis, for example, it took seven years for Euro Area GDP to get back to its pre-crisis level. And growth never reconnected with the trend we thought possible before 2008. But during the pandemic, though GDP saw its steepest collapse on record, the overall economy has reopened largely intact. We now expect GDP to exceed its pre-pandemic level by the end of this year, which is three quarters earlier than we forecast last December. And it should come close to reconnecting with its pre-crisis trend in 2023. From its trough, the recovery in GDP is steepest in the Euro Area since 1975. The outcome is largely attributable to the combined response of monetary and fiscal policy, which has preserved both demand and supply. For instance, real labour income fell by 3.6% in 2020. But household real disposable income dropped by only 0.2% because government transfers actually filled the gap. This is in stark contrast with the sovereign debt crisis when disposable income fell by not 0.2 but 2% year on year. The atypical nature of the recovery is creating frictions in the economy, which can produce opposing effects on growth and inflation. In certain sectors, supply shortages are holding back production, which is unusual so early in the business cycle. ECB analysis finds that exports of Euro Area goods would have been almost 7% higher in the first half of 2021, were it not for supply bottlenecks. These risks to growth could mount if the pandemic continues to affect global shipping and cargo handling, as well as key industries like semiconductors. But at the same time, the reopening is also pushing up inflation, which reached 3% in August and is expected to rise further over the coming months. Higher inflation today is largely the result of two exceptional effects. Let's go through them. First, inflation collapsed last year when lockdowns were imposed, which is creating strong base effects as activity recovers. Half of total inflation in the Euro Area today is due to energy prices, which are making up the lost economy. Base effects from last year's German VAT rate cut and the unusual timing of sales periods are also playing a role. In fact, the low inflation rate last year and the high inflation rate this year equal, on average, the inflation rate observed in 2019 before the pandemic. So the price level now, is roughly the same as if inflation had remained stable at its pre-pandemic level. Second, imbalances between demand and supply in some sectors are pushing prices up. Goods inflation rose to 2.6% in August, well above its historical average of 0.5% in August. Goods inflation rose to 2.6% in August, well above its historical average of 0.6%, as in addition to the base effects I just talked about, global supply chain disruptions met a sharp recovery in demand for durable goods. Consumption of those durable goods is already 1% above its pre-crisis trend, while shipping costs are around 9 times higher today than in June last year. Services inflation has also been rising to 1.1% in August, and it would have reached 2% if we were using the consumption weights of last year, slightly above its historical average. This is also largely the result of demand returning to the sectors hardest hit by the lockdowns. Inflation in those high-contact services accounts for virtually all of the rise we are seeing in services. Once these pandemic-driven effects pass, we expect inflation to decline. Base effects should drop out of the year-on-year calculation early next year, although we are seeing further increases in oil and gas prices. It is harder to predict how long supply chain disruptions will last, but the ultimate impact on inflation will depend on how persistent they are and whether they feed through into higher than anticipated wage rises. So looking back, what are we learning? Remember, following the Japanese earthquake and nuclear disaster in 2011, production is estimated to have returned to normal then after seven months for Japanese firms. However, given the special nature of the pandemic and of the recovery, it cannot be excluded that the resolution of supply-side bottlenecks may take longer now. Monetary policies should normally look through temporary supply-driven inflation so long as inflation expectations remain anchored. Now indeed, we are monitoring developments carefully, but for now, we see no signs that this increase in inflation is becoming broad-based across the economy. A trimmed mean of inflation, that is, which removes the items with the highest and lowest inflation rates, stood at 2.1% in August. Furthermore, wage developments so far show no signs of significant second round effects. Inflation expectations also do not point to risks of a prolonged overshooting. Long-term market-based measures have risen by around 50 basis points since the start of the year to now around 175%, and survey-based measures have risen slightly to 1.8%. Now, this represents a move in the right direction, but it is still some distance away from our symmetric 2% target. In fact, looking beyond the pandemic, we expect inflation to only slowly converge towards 2%. This is visible in the outlook for underlying inflation, which is a good indicator of where inflation will settle over the medium term. We currently project core inflation, which is one measure of underlying inflation, at 1.5% in 2023. Our survey of monetary analysts also points to a gradual convergence of inflation, which is expected to climb to 2% and stabilize at that level only five years from now. This partly reflects the continuing pool of the structural factors that depressed inflation before the pandemic. But the pandemic has also created some new trends, which may have implications for the inflation outlook. So, let me point to three of them. Demand side, supply side, green transition. Let's look at the demand side of the economy first. Historically, core inflation in the euro area has mostly been driven by services inflation, which has contributed 1.1% points to the long-term average of 1.3% point. This is both because services have a higher weight in consumption and because goods inflation has been held down by global forces of automation, competition, globalization. Services inflation is closely linked to the strength of the domestic economy. It depends heavily on wage growth, as wages make up around 40% of the inputs for consumer services, which is double the share for goods. And robust domestic demand is crucial for a strong pass through from wages to services prices. So, the key question today is whether the transition out of the pandemic could lift the outlook for domestic demand and as a result contribute to more dynamic services inflation. And here we see forces that point in different directions. First, owing mainly to lockdowns, households are sitting on a large stock of savings that they have accumulated during the pandemic. Our new consumer expectation survey suggests that households are not currently planning to spend all those savings. But this might change if the economy continues along a dynamic recovery path, causing people to adjust their risk assessment. Indeed, research suggests that consumption is influenced by people's past experience of recessions. And the previous recessions in the euro area hit consumers especially hard. From the onset of the great financial crisis and the sovereign debt crisis, as I said, it took seven years for consumption to get back to where it was at the start of 2008. But by the end of 2022, we expect consumption to be almost 3% above its pre-pandemic level. And if that positive outlook is appropriately supported by the right policy mix, it could produce a virtuous circle where people become more optimistic, upgrade their expectations of future income, and then spend more of the savings that they have built up. This would help close the output gap from the demand side and put upward pressure on wages. At the same time, there are forces that point to a slower pickup in services inflation. As I said in my speech here, exactly a year ago, there are limits to how much services can be consumed, meaning that they are unlikely to benefit from the same kind of pent-up demand as goods. At the end of the second quarter, services consumption was still about 15% below pre-pandemic trend, even as restrictions were being eased. The pandemic has also produced considerable slack in the labour market. Employment is now recovering quickly, but we have so far observed that labour force participation is rising even faster. Now, this is good news for the economy, but it also means that we expect unemployment to fall below its pre-crisis level only in the second quarter of 2023 and wages to grow only moderately. So that was for the demand side. The second trend is related to changes on the supply side of the economy. The pandemic has delivered a major shock to global supply chains and domestic labour markets. It has significantly accelerated the process of digitalisation, according to one estimate by seven years in Europe, and it may have distributional consequences that lead to changes in social contracts. In the long run, some of these changes might dampen inflationary pressures. For example, digitalisation could trigger a second wave of globalisation based on the virtualisation of services. It might lead to higher trend productivity, which could temper unit labour cost growth, even as wage growth becomes stronger. And it could also shift activity more towards digital superstar firms that have considerable market power and whose pricing is less sensitive to the business cycle. But over the coming years, there is also a chance that prices will be pushed up. For instance, today's supply shortages may induce firms to diversify their supply chain or reshor some of their production. Previous pandemics like SARS were found to have exactly that effect. That process could lead to higher cost structures that prioritise resilience over efficiency, which are then passed on to consumers. Not to mention that geopolitics might also interfere in trade patterns and accelerate these shifts. In parallel, faster digitalisation in Europe could initially create skill mismatches and scarcity, leading to wage increases even in the presence of persistent slack. The rate of job reallocations in major economies is estimated to double between 2019 and mid-22. This dynamic could also be reinforced by a renewed focus on inequality, which could lead to upward pressure on wages via rising minimum wages. Let us now look at the third trend. We've looked at the demand side, the supply side. Let's look at what comes next, which is probably the most important yet least explored at this point in time, and that is the green transition, the shift towards a low-carbon economy. The pandemic has given the green transition a boost. It could lead to an accelerated increase in auction prices in the EU emission trading system, the introduction of carbon prices, covering a wider range of economic activities, and the adoption of a carbon border adjustment mechanism, all of which could have a direct inflationary impact. The network for greening the financial system estimates that implementing ambitious transition policies in Europe could gradually increase inflation relative to its previous trend by up to one percentage point over the transition period before returning to that trend. The green transition is also likely to make the pass-through of energy prices to consumer prices more complex. As energy supply shifts towards renewable sources, it will no longer be sufficient to look mainly at oil prices and futures. We will also have to understand the energy mix and how the different sources are linked and can be substituted for each other. Renewable energy in the euro area has increased from 5% of total available energy in 1990 to about 15% today. Similarly, the share of natural gas has increased from 17% to 24%, while oil has dropped from 43% to 38%. The ongoing rise in natural gas prices is testament to the complexity this creates as that rise partly reflects unusually low wind energy production in Europe this summer and the need to fill the gap with conventional energy sources that can be mobilized quickly. This in turn is having knock-on effects on other industries that rely on natural gas like fertilizer manufacturing and the industries that are dependent on byproducts of fertilizer production such as food packaging. So we will need to understand these various transmission channels better. The impact of the green transition on inflation will ultimately hinge on the development of energy supply and the net effects of fiscal measures. The increased use of natural gas to stabilize electricity production is only a bridge technology and will over time subside as new technologies for energy storage and distribution are more widely deployed. And the impact of carbon pricing will depend on whether the additional revenue is used to cut other consumption taxes such as electricity taxes of VAT, directly support vulnerable groups or foster green investment. If it is not there is a risk that higher carbon pricing might reduce purchasing power and lead to relative price changes that push down underlying inflation. Research finds that introducing carbon taxes in euro area countries tends to raise headline inflation but lower core inflation. So how should monetary policy behave in this environment? The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term while also nurturing the positive demand forces that could durably lift inflation towards our 2% inflation target. Our new forward guidance on interest rates is well suited to manage supply side risks. This guidance ensures that we will only react to improvements in headline inflation that we are confident are durable and reflected in underlying inflation dynamics. And the fact that inflation can move moderately above target for transitory period allows us to be patient about tightening policy until we are certain that such improvement is sustained. In terms of supporting demand our monetary policy will continue to provide the conditions necessary to fuel the recovery. Indeed our forward guidance has already led to a better alignment of rate expectations with our new inflation target while helping to strengthen inflation expectations which lowers real interest rates. We expect to see further progress toward an even tighter alignment between the expected time of lift off for our policy rates and the most likely inflation outlook as markets continue to absorb the rationale and key purpose of our forward guidance. All this should provide a decisive boost to private spending once the uncertainty brought about by the pandemic fades, especially given the new investment needs created by the green and digital transition. The European Commission estimates that we need to see investment of around 330 billion every year by 2030 to achieve Europe's climate and energy targets and around 125 billion every year to carry out the digital transformation. Going forward the contribution of fiscal policy and therefore the appropriate policy mix will remain important. Fiscal policy is likely to stay supportive with the cyclically adjusted primary balance expected to be minus 4.1% this year minus 1.6% next year and minus 1.5% in 2023. But the scope of pandemic related fiscal transfers will need to change from a blanket based approach to a more targeted action plan. Fiscal policy will need to be surgical, meaning focused on those who have suffered particular hardship. It will need to be productivity enhancing, meaning that it facilitates structural changes in the economy and shifts activity towards future oriented sectors and delivers on the agreed reform programs under the recovery and resilience facility. And taking a medium term perspective fiscal policy will need to follow a rules based framework that underpins both debt sustainability and macroeconomic stabilization. For our part monetary policy is committed to preserving favorable financing conditions for all sectors of the economy over the pandemic period. And once the pandemic emergency comes to an end, which is drawing closer, our forward guidance on rates as well as purchases under the asset purchase program will ensure that monetary policy remains supportive of the timely attainment of our medium term 2% target. So in summary and to conclude, the pandemic has caused a recession like no other and a recovery like no other that has few parallels in history. The inflation response reflects the exceptional circumstances we are in. We expect that those effects will ultimately pass. But the pandemic has also introduced new trends that could affect inflation dynamics in the years to come. Those trends could produce both upward and downward price pressures. So monetary policy must remain focused on steering the economy safely out of the pandemic emergency and lifting inflation sustainably towards our 2% targets. As Dickens would have said, it was the best of time, it was the worst of time. Those are certainly testing times where good work is needed and resilience. Thank you.