FRANKFURT (MNI) – Rising prices for imported goods and services
cannot be ignored by monetary authorities, European Central Bank
Executive Board member Lorenzo Bini Smaghi said Thursday.

“To a greater extent than in the previous decade, the strong
dynamics of the rest of the world are likely to result in a higher
inflation rate for imported goods, whether commodities or manufactured
goods and services,” Bini Smaghi said in remarks prepared for delivery
in Bologna, Italy.

Bini Smaghi echoed sentiments made Wednesday by his Executive Board
colleague Juergen Stark that no solace can be taken from low core
inflation.

“A permanent and repeated increase in the prices of imported
products will tend to impact on inflation in the advanced countries,
including the euro area,” Bini Smaghi stated.

“This effect occurs through two channels. The first is simply
mechanical, by the weight of imported goods in the basket of goods and
services purchased by households,” he stated.

“For example, food and energy account for about 30% of the average
shopping basket in the euro area. Assuming an average increase of these
products by 4% a year, more or less in line with the rate of growth of
the world economy … average prices in the euro area will increase by
1.2% only because of the effect of these products,” he outlined.

“It is therefore not a component that can be ignored, as it would
be if core inflation were used as a reference,” he said. “This concept
is obviously losing its relevance in a global world.”

The second channel concerns the implications for other products
that make up 70% of the shopping basket, Bini Smaghi explained.

If such products are only produced domestically, then “the prices
of these products grow at a rate of 2% per year, overall average
inflation is 2.6%, exceeding the 2% objective of most central banks in
advanced countries, including the ECB,” he pointed out.

The central bank is thus faced with two alternatives: “The first is
to revise the inflation rate objective upwards, taking account of
imported inflation, or only to look at non-imported inflation and to
ignore the rest,” he outlined.

“This strategy is complex because first and foremost it is not
clear how much the imported inflation rate will be going forward, which
is not under the control of the central bank,” he added.

“Moreover, a higher inflation objective implies an increase in
inflation expectations, and thus of long-term interest rates, which must
sooner or later be accompanied by an increase in short-term rates,” he
said.

“Finally, if the inflation rate objective is increased, it will not
be easy to convince national market participants not to include this
increase in their behaviour, including in wage demands,” he cautioned.

“In a situation of high unemployment, this risk is limited, but
gradually as the economic recovery gets under way the risk of
second-round effects increases,” he warned.

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