Good afternoon. It's lovely to be here. And it's particularly lovely because for once the preceding speaker is even taller than me. It is so often the case that I have to go bend down. No. Fantastic. It was a great pleasure to listen to the Chancellor and it is an even greater pleasure and a great honor to be the second speaker tonight. Christian, I would like to thank you as president of the association for having invited me on this occasion.
So what I understand is that when this association was founded, it was a new beginning for Germany. Europe had come out of that period of time devastated by a tragic period in its modern history, but it was about to enter into the golden age of peace and economic growth as described very eloquently by the Chancellor.
Fast forward to today and clearly we are in a far more uncertain situation, very uncertain about the direction Europe will take and probably one of the most difficult at any point in time in the last 75 years. And much of that uncertainty is not from within, it's from outside our borders.
My suspicion is that when historians look back at this period, what will stand out is the sheer relentlessness of it all. A once in a generation pandemic, followed by a land war on our continent at our doorstep, followed by the worst energy crisis in 50 years. Not this one, remember? 2022. Followed by the most sweeping tariff increase since the 30s, and now a military conflict that has shut down the world's most important energy chokepoint, the Strait of Hormuz.
I have to tell you that in our grim scenarios back in 2020 when we had in mind that this could happen, the worst that could happen at the time in our scenario was a third of the traffic being halted. A third.
Now, each of these shocks that I have just mentioned has torn away something that Europe had come to take for granted. A secure supply of cheap energy, a predictable trading relationship with the United States, the foundation of our post-war military security.
I'm going to ask for your indulgence at this point in time because I will try to quote Hegel in German. So bear with me.
For those who did not understand my German, you are forgiven. And the English goes as follows: The owl of Minerva begins its flight only as dusk falls. Why would I say that? Probably because I like owls. You know, I'm not a hawk. I'm not a dove. I'm an owl.
But I'm saying that because it means understanding comes after the experimentation, not before it. And the truth is that these painful years have taught us a great deal already. And some of those lessons are already being acted upon.
The transformation of defense policy in Germany over the past year would have been unthinkable without the shocks that preceded it. But there are also lessons on how we navigate the economic consequences of large shocks and those lessons are directly relevant to the situation that we are facing today.
So building on this I'm going to focus on three particular areas. One, I'm going to try to figure out at this time at 10 to 7 p.m. today where the economy stands. Two, what monetary policy needs to see to calibrate its reaction. And three, how fiscal policies can help keep the inflation shock as small as possible.
The economic picture remains deeply uncertain. You've heard that many times already. The stop-start-stop nature of the conflict, war, ceasefire, peace talks, they collapse, a naval blockade, its lifting, its reinstatement makes it exceptionally hard to gauge the duration and depth of the consequences. Hence the reason I'm saying at 7:00 p.m. today, who knows what comes next?
But it is clear that there is no easy path back to where we were before the conflict erupted. It will be different. In March, we published our baseline projection for the economy alongside two alternative scenarios, an adverse scenario and a worst and adverse, a severe scenario. Each driven by higher energy prices. And all three, the baseline, the severe, and the adverse, all three of them saw higher inflation and lower growth than what we expected back in December with the damage escalating with the severity and the duration of the shock.
Now the critical question that we ask ourselves and this will be obviously the case in future monetary policy meetings that we have is which path are we on? Are we baseline? Are we severe? Are we adverse?
The supply disruption is enormous. Even if you account for the pipeline redirection by some of the Gulf countries and if you account for the release of some of the strategic reserves, the net loss of oil is estimated at around 13 million barrels per day. That is 13% of global consumption and that is before the US blockade. So at a time when the Iranian shipment could actually travel all the way to India or China.
But you observe as much as I do how markets react. And so far we have not seen energy prices rise far enough to push us squarely into the adverse scenario. While both oil spot and future prices are above what we assumed in our baseline, markets appear to be betting that the disruption will be short-lived.
European natural gas prices are below our baseline, reflecting, among other things, gas to coal switch in Asia and relatively mild weather in China so far. If the conflict resolves quickly, the direct energy price shock could prove to be at the smaller end of expectations and the economic impact could be contained, but the outlook remains fragile and worse paths are still possible.
Every day the conflict continues, the wider the gap between energy supply and demand, the longer the normalization and the longer the disruption, the further the spread of the effects, not only through higher energy costs, but through the loss of critical inputs. Let me mention three of them.
Around a third of helium. Now, we've all become chemical experts. I had never heard about helium before, and I'm sure many of you know what helium was about a month ago, but I'm not sure. So a third of helium produced globally comes from the Gulf and its loss would be felt severely in the semiconductor fabrication and in high-tech manufacturing. Example number one.
Example number two, close to a fifth of global methanol production is also at risk with severe consequences for the chemicals and plastic industries. And third, a third of the fertilizers is shipped through the Strait of Hormuz. Now that is also at risk and it matters particularly in the southern hemisphere where the planting and therefore the fertilizers is badly needed.
Now I'm not saying that just out of interest for agriculture. Don't forget I was minister of agriculture in France for a month and a half. But because it matters to me as a central banker now because if the price of food increases significantly, it is not going to just be the price of food. It is going to be inflation expectations because we know that people are particularly attentive to two things. The price of food processed and unprocessed and the price of gas at the petrol station.
So here are three indirect consequences of what's happening in the energy world. So if the disruption persists long enough, the adjustment shifts from prices, which we are putting up with now, to possibly rationing with very different economic consequences. Higher prices are primarily inflationary. Shortages hit output directly and are worse for growth.
Overall, there have been so far limited signs of supply chain disruption both globally and in the Euro area, but local tensions are visible. Jet fuel prices have roughly doubled since the outbreak of the conflict and rationing has been imposed at some individual airports in Europe since early April. And I'm not talking about what's happening in the rest of the world. I'm just back from the IMF and the World Bank spring meetings like many of you. And you might have bumped into colleagues from Asia in particular some of the low-income countries or emerging market economies that are taking a much more severe hit than us and are moving into rationing.
So setting monetary policy in this environment is challenging. I can assure you we know we're facing a major shock. And if you listen to Fatih Birol, the head of the International Energy Agency, he thinks that it is the largest oil supply disruption in history.
But past experience has taught us that the size of the shock alone does not determine its economic consequences. There are two other factors which are critically important to really assess the size of the shock and to determine what is the best policy response. The first is the duration of the disruption. As the economic picture just described makes clear, the longer the conflict lasts, the worse the outlook becomes and not in a linear way. Duration is as a result key for judging which scenario we are facing.
In 2022 it was clear we were going to move away from Russian gas for good. Took a little while but it was not... there was no way back. We had to build new LNG infrastructure. Germany set standards in that respect. We had to find new suppliers and we had to compete in the global market for imports.
Today, the range of possible outcomes is far wider. On the 31st of March, when the conflict appeared to be escalating, oil prices would have placed us squarely in the adverse scenario. 10 days later after the ceasefire was announced, we were in between the adverse and the baseline. We're watching what comes next.
The second factor in addition to the duration is the pass-through of energy prices to broader inflation. What other people would call the second round effect. The same energy shock can play out very differently depending on the economic environment in which it lands.
Remember 2022, we were coming out of COVID. There was strong demand. Global supply chains had bottlenecks right left and center and acute labor shortages created the conditions for a broad pass-through. Compare that not with today but when energy prices spiked in 2008 and 2011, the economies were weaker. Remember global financial crisis, the European sovereign debt crisis and it meant that higher prices stayed largely in the energy compartment.
What about today? Today we see two forces pulling in opposite directions and they're both likely to influence the inflation response this time. First force, households and firms, corporates, your clients have just lived through a large inflation shock and may be more sensitive to rising costs. The muscle memory is fresh. Incoming surveys suggest that the selling price expectations of firms have increased and that households are already paying much more attention to prices.
The other force, higher energy prices and weaker consumer sentiment will weigh on demand particularly given that growth while recovering was moderate before the conflict began. That could limit the extent to which prices and wages increase. The negotiations your clients will be having both in terms of salary increases and in terms of invoicing to customers will be critically important and extremely informative to us because that could limit the extent of price and wage increase.
In the two most recent comparable episodes, the Gulf War of 1990-1991 and the Russia invasion of Ukraine, oil supply shocks reduced Euro area GDP by around 0.4% on average in the first year. And the relative importance of these two forces that I have just identified, the muscle memory on the one hand, the dampened possibly demand on the other hand, that will only become clear as we see actual data on firms' pricing behavior and wage negotiations.
This double uncertainty about the duration of the shock and the breadth of pass-through argues for gathering more information before drawing firm conclusions for our monetary policy. But there is another factor that will shape the inflation outcome. The design of fiscal policy. I'm sorry that the Chancellor really had to go because I had a couple of messages for him.
I've been in politics for six years of my life and I know how it feels. Governments around Europe are facing strong pressure. Pressure to cushion the blow for households when energy prices surge. But the 2022 experience shows that both approaches to providing support, whether they are price-based measures or income-based measures, involve difficult trade-offs.
The price-based measures can bring down inflation, but at the cost of blurring the signal that households and firms need to reduce energy consumption. Measures such as tax cuts and price caps reduced inflation by close to one percentage point in 2022. This was valuable because energy prices are highly, as I said, visible to the public and weigh heavily on inflation expectations.
But when such measures are broad and open-ended, the public has no incentive to cut back on energy use. And when they are eventually unwound, which Germany did as it had promised on the date it had promised. Not all member states did that. But when they are unwound, they raise inflation mechanically. And during the last shock, the withdrawal of fiscal support contributed to extending the period of above target inflation well into 2024 and 2025.
That's for the price-based measure. Now, the income-based measures can protect citizens, but at the cost of stimulating the economy too much. Fiscal transfers to lower income households are socially necessary and economically stabilizing. But when support is extended across the income distribution without any targeting, it sustains demand that firms can then use to pass on higher costs, forcing then monetary policy to tighten more than it would otherwise would.
In 2022, fiscal measures to compensate for higher energy cost and inflation amounted to 1.7% of GDP. That made fiscal policy net expansionary at a time when monetary policy was tightening with the aim to dampen demand. So you had fiscal support that increased demand generally, income-based, and as a result of that monetary policy had to come in to dampen demand. We have to learn from that particularly because today we have another constraint.
In the years since the pandemic, an expectation has taken hold that governments of all colors and calibers will step in to shield households and firms from every large shock. But guess what? In the meantime, fiscal space has shrunk. Governments that try to cushion every shock for every household risk undermining fiscal sustainability at their peril. That's what I wanted to say to the Chancellor.
So it doesn't mean that governments have no response but it means that selectivity is not just desirable but necessary. The lesson of 2022 is clear. Support has to be temporary, so a period of time at the expiry of which you waive it, targeted, focused on the most in need, and preserves the price signal that can protect the move towards a different energy mix.
So to conclude, Europe faces a decisive moment now and probably one of the most decisive in the last 70 years, 75 years since your association was founded. The pace of change is disorientating. For those of you who were last week in Washington, our heads were all over the place. Not much by way of a straight compass, which reinforces my conviction that we're poor central bankers. We have to stay focused on what we have to do, which is deliver on our mandate, 2% medium-term target. We're not going to move away from that.
The certainties of the past are vanishing. The allies are vanishing. Those who are friends could be foes. Those who are foes might be friends. One thing is certain. We can only be stronger together as Europeans. And I would advocate exactly what the Chancellor has advocated. One market, a strong capital market. Let's make sure that the massive savings that accumulate in many of your institutions are actually invested in this continent, in Europe, in order to make sure that we can be sovereign at home and autonomous as much as is possible.
It might take a little while because defense requires massive investment in order to assure one of the attributes of an international currency of reserve. It will come. But we have to all do what is necessary. Be together and not bicker about stupid things when our survival is at stake. Thank you.
