European monetary economy: global challenges and development trends

Abstract

The paper examines the key challenges and trends in the development of the European monetary economy, substantiates inflationary factors and fundamental factors of changes in the structure of the economy under the influence of geopolitical transformations and changes in supply chains, identifies financial and economic shocks from a sharp increase in the ECB key policy rate, and substantiates the impact of tight monetary policy on the decline in economic activity and structural deformations in the financial sector. The author proves that Russia's full-scale invasion of Ukraine has led to serious problems and disruptions in supply chains and bottlenecks in energy supplies in Europe. This, in turn, has led to rapidly rising inflation, significant changes in international trade, and forced monetary and fiscal policy to respond on an unprecedented scale. The immediate response of central banks was to raise interest rates in order to contain inflation. The rapid increase in interest rates has had a significant impact on financial stability. High interest rates, in particular, have led to a low ability to service the debts of heavily indebted corporations and have changed the structure of financial institutions' balance sheets. The change in the monetary policy regime has triggered new financial and economic challenges and large-scale adjustment processes in households, companies, and financial markets. It is substantiated that due to the imbalance in the portfolios of non-banking institutions, the sector still demonstrates high credit and liquidity risks. In the context of macroeconomic uncertainty and market volatility, they remain vulnerable to asset price corrections. Parts of the non-bank financial sector also have significant on- and off-balance sheet debt. Weaknesses in this sector pose additional risks to the financial system, including through its linkages to the banking sector. In such circumstances, the credibility of central banks is a key asset of the monetary economy, which is very important in times of high uncertainty. Monetary policies based on central bank credibility, such as inflation targeting, help to reduce inflation, and it is therefore important to demonstrate a commitment to ensuring that inflation returns to its medium-term target in a timely manner. In the euro area, the medium-term inflation target is 2%. In making interest rate decisions, the European Central Bank is guided by three considerations: first, the outlook for inflation in light of economic and financial developments; second, the dynamics of core inflation; and third, the impact of monetary policy on funding conditions and the real economy.