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Inflation surge of 2021
In the summer of 2021, coinciding with the European Central Bank's announcement of its revised monetary policy framework and its initiative for climate action, the eurozone witnessed a notable inflationary surge. This resurgence of inflation continued to escalate over the following year, culminating in inflation rates reaching double digits for the first time since the 1970s, a year after the ECB's strategic updates. The inflation rate reached an unprecedented peak of 4.9% in November 2021, marking the highest level since the introduction of the euro.

Framing of the crisis
The new era of inflation prompted a significant shift in the European Central Bank's framing compared to its stance in the 2000s. Initially, from its inception until the 2007-2009 financial crisis, the ECB's primary objective was price stability, adhering to strict institutional rules that minimized policy trade-offs with other goals beyond price stability. This approach was rooted in the "Central Bank Independence template", advocating that central bank's limited role to price stability and its independence were optimal.

However, the post-financial crisis landscape, especially during the sovereign debt crisis of the 2010s and subsequent economic stagnation era, necessitated a substantial revision in the ECB's strategy. The ECB moved away from its original Central Bank Independence template, leading to a blurring of its objective hierarchy. It adopted new strategies such as acting as a lender of last resort for the banking system and fostering growth through very low interest rates and extensive asset purchase programs, which were designed to help stabilizing specific market segments and in the end revive growth.

In 2021, the European Central Bank embraced a significant strategic pivot by adopting its Climate Action Plan along with a new monetary policy strategy. This shift aimed to institutionalize the ECB's evolving role, moving beyond the singular focus on price stability—a policy shaped largely by the aftermath of the European sovereign debt crisis. Instead, the ECB began acknowledging its multifaceted responsibilities, which now include maintaining financial stability, supporting economic growth, and addressing climate-related objectives. However, with the surging of inflation in 2021, some wondered as to whether the European Central Bank would revert to its foundational role, predominantly focused on chasing the “inflation monsters”. The term “inflation monsters '' echoes the 2010 video of the ECB where two young people are facing a blue inflation monster unleashing banknotes and threatening to wreck the economy. Nevertheless, ECB policymakers effectively drew connections between the Central Bank Independence (CBI) framework and the experiences of the stagflation era to rationalize their decision to increase interest rates, avoiding the need for a discourse on regime change. In doing so, they recognized the complex trade-offs inherent in balancing various macroeconomic objectives and the challenging decisions they had to face.

It was with this new monetary strategy that the eurozone found itself facing rising inflation in 2021. Recent studies stated that key debate among policymakers centered on whether this inflationary trend would be transitory or permanent. Initially, both the European Central Bank and the Federal Reserve misjudged the situation, assuming the inflation spike to be temporary and expecting a swift return to their inflation target. This misperception led to the ECB's initial inaction regarding its monetary policy.

Response to the 2021 inflation crisis
After big increases in the inflation rates throughout 2021 and 2022, the European Central Bank and the FED finally decided to raise their interest rates and abandon their very low interest rates, for the first time since the sovereign debt crisis and the end of the CBI era, as it had become clear the inflationary trend wasn’t temporary. This decision came in late July 2022 for the ECB, when the inflation rate in the eurozone was already at 8.9% and had been higher than the 2% target for more than a year, and in March 2022 for the FED. The European Central Bank's response to the Federal Reserve's actions can partly be attributed to concerns about imported inflation from the USA. Specifically, if the FED increases its policy rates while the ECB remains static, it could lead to a depreciation of the euro against the dollar. Such a scenario would likely result in higher import costs for the eurozone, as many global trade goods are priced in dollars. On the other hand, this would benefit the US economy by making imports from the eurozone cheaper.

Furthermore, the impact of US dollar appreciation, following the FED's policy rate hikes, tends to be more pronounced in the international inflation rates of energy and food. These commodities are commonly priced in US dollars, making their inflation rates more sensitive to exchange rate variations. In the European Union, public inflation expectations are significantly influenced by the prices of energy and food. Thus, this form of imported inflation can further exacerbate overall inflation levels of the eurozone.

The ECB also declared its intention to systematically diminish net asset purchases within their asset purchase program (APP) and end them under the pandemic emergency purchase program (PEPP) launched during the COVID crisis by the first trimester of 2022. On the other hand, the Federal Reserve initiated the reduction of its asset purchase program in November 2021, to finally stop it by March 2022. The Asset Purchase Programs of the ECB initially boosted asset values on bank balance sheets and led to expectations of lower future short short-term interest rates. These programs also raised inflation expectations, eventually reanchoring long-term inflation expectations. Phasing out the Asset Purchase Programs thus signals alignment with the different policy rate hikes in an attempt to cool down the economy and demonstrates a commitment to combating inflation.

Research indicates that the European Central Bank responded to the escalating inflation more slowly and cautiously than the FED, showing hopes that a moderate tightening of monetary policy would suffice. The ECB was notably slower in acknowledging the mistaken nature of its initial assumption that the inflationary trend would be transitory. The transition away from extremely low interest rates was soon accompanied by various rate increases, culminating in the ECB's main rate reaching 4% by the end of September. In contrast, the FED's latest rate hike elevated the Effective Federal Funds Rate to 5.33% in August, underscoring a more aggressive and rapid tightening of monetary policy compared to the ECB's approach. However, the global monetary tightening cycle turned out to be the most synchronized one in the past half-century. By February 2023, more than 90% of economies had hiked their policy rates. The latest peak of highly synchronized action by central banks was during the 1970s and the oil prices shocks where 70% of them had raised their interest rates.

Critics regarding the new monetary policy
Criticism first emerged regarding the methodologies used for inflation estimation and their failure to anticipate the inflation surge. A primary critique focused on the inadequacy of traditional tools like the Phillips Curve, which examines the relationship between inflation and certain economic activity indicators, for accurately forecasting inflation. During the 1970s, the Phillips Curve also faced significant criticism for its inability to accurately predict the inflation experienced in that decade. This period marked a critical reassessment of the curve's predictive capacity, particularly in the context of the economic phenomena of the time. Traditional indicators used for forecasting economic dynamics, such as the output and unemployment gaps, were found to be inadequate in signaling the overheating of the economy and the prevailing tight labor market conditions. Moreover, the important belief among central banks that sustained inflationary increases are a consequence of unanchored long-term inflation expectations was challenged during 2021-2022. During this period, inflation expectations remained relatively stable, leading to the misinterpretations by the European Central Bank and other monetary authorities regarding the inflationary trend's nature. Both the FED and the ECB argued that the rise in inflation was only temporary and was the sole result of post-pandemic supply disruptions on a few selected goods and services (food and energy). The FED and the ECB then maintained their expansionary monetary policy, keeping interest rates low.

Some critics have also emerged saying that it was complicated for independent central banks, including the ECB, to accurately assess during a synchronized policy rate hike the potential spillovers of cross-countries monetary policy on the inflation. This might lead to excessive monetary tightening (higher interest rates) in unusual circumstances.

Concerns have also been raised about the European Central Bank's effectiveness in addressing the recent surge in energy prices. Some experts suggest that the eurozone should be viewed as a small open economy, implying that changes in its demand may not significantly impact global prices. Moreover, they argue that monetary policy might have minimal influence on the global demand for energy. This is because household demand for essentials like heating and transportation is believed to be relatively insensitive to price changes. Additionally, while a stronger euro could theoretically lead to lower import prices, it's uncertain whether these savings would be effectively passed on to consumers.

However, recent studies contradict these views by highlighting the significant role of energy prices in the transmission of monetary policy within the eurozone. An increase in the ECB's policy rates tends to appreciate the euro against the dollar. This appreciation can lead to higher local energy costs but may also reduce demand, potentially lowering global energy prices. These studies support the ECB's decision to follow the Federal Reserve's lead in raising policy rates, which appears to have been a strategic move to curb imported inflation and address the spike in energy prices.

Effects of the monetary tightening
The implementing a of tighter monetary policy has emerged as the eurozone solution to fight the latest inflationary pressure. However, this approach bears the risk of hindering the progress of the economic revival post-COVID.

Raising interest rates is a strategic move by the ECB with specific aims: to decelerate economic activity, stabilize inflation expectations, and steer towards lower inflation levels. Studies have shown that as interest rates rise, the price on the world market does not really change. However, the Euro becomes more attractive to investors, leading to its appreciation against other currencies. This change benefits households paying for gas in Euros, as it translates into lower prices for dollar-traded oil.

On the other hand, the increase in interest rates, while helping to suppress prices, also places strains on the manufacturing sector and the labor market. The aftermath of this shock sees tighter financing conditions and a dip in demand, resulting in a slight uptick in unemployment rates, going beyond 0.1 percentage points. Although the study shows that manufacturing sector quickly rebounds, returning to its pre-shock state within about three months, the impact on unemployment rates lingers for a longer period.