Victory over inflation, but at what price?
When the annual inflation rate in the eurozone climbed to over ten per cent in October 2022, the highest level since the introduction of the euro, it became clear that economic policy was facing a challenge such as Europe had not known for decades. The prices of energy and food rose at a pace that caught both households and businesses by surprise, while in the USA inflation in mid-2022 reached its highest level since the early 1980s. However, unlike previous episodes, this time it was not merely a case of an overheated economy, but of a combination of several shocks that reinforced each other.
The Covid-19 pandemic disrupted global supply chains: factories in Asia were temporarily closed, ports were overloaded and the cost of sea freight multiplied. At the same time, states supported the incomes of citizens with huge aid packages, so that demand came back strongly after the reopening of the economies, while supply was still lagging behind. The decisive blow, however, came with the Russian invasion of Ukraine in February 2022, after which gas prices in Europe were at times many times higher than usual.
Both the European Central Bank and the US Federal Reserve aim for medium-term inflation of two per cent, although the mandate of the Federal Reserve additionally includes maximum employment. Their main instrument is the key interest rate, whose increase raises the cost of loans, discourages investment and consumption and in this way reduces demand. The dilemma lies in the fact that an overly cautious response could entrench inflation in expectations, while excessive tightening risks plunging the economy into recession.
All the more remarkable is the fact that both central banks long interpreted inflation as a temporary phenomenon that would disappear by itself once supply chains normalised again. Critics later noted that with this interpretation the banks had lost valuable months, in which expectations of future inflation had already begun to rise. When they finally reacted, they did so with unusual vigour: from March 2022 the Federal Reserve raised its key interest rate from almost zero to over five per cent, while the ECB raised its deposit rate from negative territory to four per cent.
The results were not long in coming: inflation in the eurozone gradually fell and in the course of 2025 again approached the two per cent target. The ECB cut interest rates for the first time in June 2024, and the Federal Reserve followed a few months later. However, the price of this victory was paid above all by debtors: anyone who was repaying a mortgage with a variable rate in those years suddenly had to pay considerably higher monthly instalments. At the same time, savers again received returns on their deposits after years of zero or even negative interest, although these were often not enough to make up for the lost purchasing power. Hardest hit, on the other hand, were households with low incomes, which spend a disproportionately large share of their budget on food and energy and therefore felt the price rises more strongly than others.
Among economists there is still debate about whether central banks have drawn enough lessons from this episode. Some argue that the late but decisive response proved correct, because inflation was tamed without a deep recession and without a dramatic rise in unemployment. Others, however, warn that structural changes such as the ageing of the population, the costs of the energy transition and growing protectionism could permanently increase the pressure on prices. If this proves true, the era of extremely low interest rates as we knew it in the decade before the pandemic is unlikely to return. For central banks this would mean that the fight for stable prices is not a completed victory, but a permanent task that requires vigilance, credibility and a willingness to make unpopular decisions.