At the Hoover Monetary Policy Conference held at Stanford University on May 10, 2025, Isabel Schnabel, a member of the Executive Board of the European Central Bank (ECB), delivered a speech that explored the evolving relationship between inflation and economic activity, as characterized by the Phillips curve.

She noted that prior to the COVID-19 pandemic, the efficacy of the Phillips curve had already been called into question, particularly following the global financial crisis of 2008. During that period, inflation rates remained stubbornly low, defying the predictions made by the traditional models that connect economic slack with inflation movements, leading to what is referred to as 'missing deflation' and 'missing inflation'.

Schnabel pointed out that post-pandemic, the dynamics shifted significantly, revealing a noticeably steeper Phillips curve across advanced economies, which included the euro area.

This indicates that the link between output and inflation became stronger than anticipated based on historical data.

She argued that the observed re-flattening of the Phillips curve following a long period of high inflation necessitates a cautious approach from central banks, recommending that the ECB maintain interest rates in a neutral territory to mitigate risks to price stability, particularly amidst increased fiscal expansions and protectionist pressures.

The implications of the slope of the Phillips curve are critical for monetary policy formulation.

Schnabel explained that if the curve is steep, central banks can reduce inflation with minimal adverse effects on growth and employment.

Conversely, a flat Phillips curve would require substantial policy interventions to influence inflation, potentially leading to uncomfortable trade-offs between inflation targets and employment rates.

Schnabel elaborated on the role of inflation expectations in determining how much deviation from these targets can be tolerated.

Firm anchoring of these expectations allows for moderate fluctuations; however, an unanchored expectation can compel a more aggressive policy response.

She warned that if central banks appear inactive in the face of rising prices, it risks undermining their credibility, a situation that can be difficult to rectify once lost.

Two primary theories were discussed to explain the inflation surge witnessed following the pandemic.

The first focused on the behavior of firms in price-setting, indicating that conventional models fail to capture the complexities of price adjustments during significant economic shocks.

When firms face rapidly increasing costs, they are more likely to raise prices frequently, thereby steepening the Phillips curve.

The second theory considered the tight labor markets and how nominal wages adjusted in response to labor demand.

Empirical evidence suggests that when job vacancies surpass unemployment levels, non-linear responses in inflation may occur as companies compete for workers.

Despite these theories, recent research has suggested a need for caution in interpreting these dynamics.

Findings indicate that the perception of a steeper Phillips curve may stem more from an upward shift due to rising near-term inflation expectations rather than an inherent steepening of the curve itself.

Schnabel emphasized that understanding the nuances of inflation expectations is critical for setting appropriate monetary policy.

Moreover, Schnabel addressed the implications of tariffs on inflation within the euro area.

The introduction of tariffs could exert persistent upward pressure on underlying inflation, influenced by simultaneous demand and supply shocks.

The future effects on economic activity in the euro area will be contingent upon the outcome of ongoing tariff negotiations, which may have a significant impact on both prices and wages.

The degree to which foreign demand may adapt to these changes, particularly in light of how differentiated products react to tariff increases, remains uncertain.

In her remarks, Schnabel highlighted the responsibility of central banks to remain vigilant and responsive to the unfolding global economic landscape, pointing out that monetary policies must be grounded in a data-dependent approach, particularly given the unpredictable nature of structural shocks.

The ECB's recent practices have leaned towards a careful examination of underlying inflation trends while acknowledging the inherently challenging and uncertain environment.