Time for a review of the ECB strategy

November 26, 2019 13:15
The ECB should confirm that it is not an inflation targeter and targets neither a nominal GDP nor a specific price level, says the author. Photo: Bloomberg

Now is the time to position for a review of the European Central Bank (ECB) strategy, which will determine how long-lasting the approach of its former head Mario Draghi will be. Surprisingly, there are many crucial questions and battle lines.

Monetary policy has become more complex since the 2007-2008 financial crisis such that a new consensus regarding the strategy would be helpful.

The last evaluation of the ECB strategy took place in 2003 and resulted in a confirmation of the monetary policy strategy with some clarifications in terms of presenting and communicating to the public its more complex aspects.

It is fair to say that some clarifications are needed as monetary policy has become even more complex since the financial crisis.

Additionally, new experiences have been met with the zero lower bound, unconventional monetary policy instruments and a world in which, contrary to previous decades, below-target inflation rates are more frequent than above-target rates.

The ECB should confirm that it is not an inflation targeter and targets neither a nominal GDP nor a specific price level.

So far, the ECB does not pursue a formal inflation-targeting strategy. The advantage of the ECB approach is that no point-target has to be met a priori at the mostly two-year horizon which other inflation-targeting central banks focus on.

This allows for a more flexible monetary policy by leaning against the wind (if monetary indicators suggest so) or for more time to meet the inflation time if adverse shocks like a commodity price increase or the bursting of an asset price bubble hit the economy.

As it has become difficult for the ECB lately to lift inflation towards its aim, it should be evaluated whether adopting a formal price level or nominal GDP target might be helpful in increasing inflation expectations.

We consider the inflation aim of the ECB as credible already and doubt that another target or strategy would change anything.

Giving up the two-pillar approach would be an unnecessary break with the Bundesbank tradition.

So far the monetary policy strategy rests on two pillars: the economic analysis with a focus on shorter-term price movements and the monetary analysis with a focus on longer-term trends.

It is true that Draghi rarely paid lip-service to the approach and seemed to put a stronger focus on short-term fluctuations of economic and financial market data. This might also explain the opposition of parts of the Governing Council (GC) against the policy package that he pushed through.

It might be the case that monetary indicators are less useful at certain times than at others.

However, no central bank would dismiss them totally. Maybe one would not develop a two-pillar approach again when setting up a new central bank in Europe. But given that this is not the case and that the focus on monetary developments was helpful in borrowing the inflation-fighting credentials of the Bundesbank, we see no merit in giving it up.

It also would unnecessarily deepen the rift between the different factions in the GC.

Some unconventional measures should remain.

The ECB has introduced several new policy measures like forward guidance and asset purchases. It would be helpful to evaluate the experience with these measures and to find a consensus in which situations they should be used.

The lack of a consensus explains the broad opposition against the decision to restart asset purchases at the last GC meeting as some members would do so only in times of higher deflationary risks.

A formal voting procedure on monetary policy decisions would be helpful.

So far monetary policy decisions in the GC are made without formal votes. The September policy meeting, however, showed that the consensus was not as broad as initially portrayed.

Formal votes would make this more transparent and would also give the less vocal members of the GC a stronger voice and impact.

The monetary policy decision was assigned to the GC instead of the ECB president for a good reason.  As committees often arrive at better decisions than individuals, then ECB president Jean-Claude Trichet incorporated this principle by trying to speak for the whole GC.

In contrast, Draghi tried to lead and convince the GC of policies he thought would be appropriate. His strong leadership might have saved the euro, but at times it might also frustrate GC members and constituents of countries of their origin if they find their opposing views not taken into account. Voting would help to assure everyone has a voice.

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Chief Economist, Head Economic Research at Bank J Safra Sarasin

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