The problem of stagflation. How should the ECB respond to the increase in inflation?

Inflation began to increase rapidly towards the end of 2021 and remained elevated throughout 2022. Higher energy prices contributed significantly to the increase in inflation. However, core-inflation, excluding the direct contribution of energy prices, was also significantly above the European Central Bank’s inflation target. Partially due to the highly expansionary monetary policy during the pandemic. This paper discusses how the ECB should respond to the increase in inflation based on historical evidence. Higher interest rates are necessary to counteract the previously expansionary policy. However, too tight monetary policy when the economy faces significant headwinds may cause a severe recession. Lessons from historical inflation episodes suggest that from a long-term perspective contractionary monetary policy is preferable despite the short-term pain. To limit the negative consequences, the contractionary policy should be coupled by supply side reforms aimed at stimulating economic growth and increasing the resilience of the European economy.