The writer is responsible for JP Morgan’s Western European Economics
Over the last decade, the consequences of eurozone inflation have been permanently below the European Central Bank’s objectives.
In other words, production and employment are lower than what is needed to achieve the ECB’s self-defined price stability measure. These losses are important in their own right, even if they do not continue in the future.
However, they also leave a legacy of wider budget deficits, higher debt stocks, and lower inflation expectations than if price stability targets were met. Its heritage makes future production losses more likely than the economic potential.
The ECB has set monetary policy for almost every period of this inflation undershoot, but ECB forecasts show that inflation will not reach its target over the normal two to three years. ECB recent Strategic review Consider why this happened and how the policy should evolve accordingly. There are few signs that it did.
The ECB can argue in its defense that it has made innovations in both the design and scale of its policy response to low inflation. In the wake of the global financial crisis, we had to deal with premature fiscal policy. The ECB also had to act as an intermediary in responding to the sovereign financial crisis, which was delayed by politicians.
The ECB lent to banks on a large scale, set negative interest rates and bought trillions of assets. Responded quickly to the pandemic.Not only are these policies still working, but also the ECB Promise To continue that action in the future. The ECB also claims that there is room to deploy these and other tools as needed.
But if the ECB has a policy tool to bring inflation back to its goal, why not deploy it? It can be argued that the impact is becoming more uncertain as policies become more unconventional than ever. The policy changes needed to bring inflation (or at least the ECB’s forecast) back to target will also increase forecast uncertainty.
For example, as asset purchases grow, the likelihood of financial instability can increase. Alternatively, the ECB may be concerned that twisted or volatile incentives for fiscal policy makers could be created by the purchase of more sovereign debt than ever before.
Such arguments can be made legally, but if it is an explanation of low inflation tolerance, it is the ECB’s responsibility to make them. In conducting these discussions, the ECB emphasizes the role that other policies and policy makers can play in their combination.
For example, if financial instability is a concern, the ECB needs to clarify that macroprudential and other regulatory interventions will become more important. If financial incentives are a concern, the ECB needs to emphasize them.
Instead of participating in these discussions, the ECB has chosen to obfuscate that policy is designed to be achieved. Recently, an interim goal was introduced to maintain “favorable funding terms”. However, it does not provide a convincing quantitative definition of its purpose (by design). There is also no systematic explanation as to why that intermediate goal is the right way to achieve price stability.
A strategic review revealed that the ECB weights the deviation of inflation above and below the 2% target. It also introduced the notion that inflation is more tolerant of overshoots after a period of policy constraints due to effective restrictions on how low interest rates can be reduced.
However, the potential impact of these ideas on building the credibility of the inflation target is undermined by the ECB’s failure to explain why the forecast is currently allowing an inflation undershoot outlook. ..
The Bank of Japan’s recent experience shows that large-scale, sustainable monetary policy measures, not to mention the tolerance for inflation overshoots, are not sufficient conditions for them to occur.
The US Federal Reserve shift Its regime to ensure that more limited inflation undershoots are offset over time. ECB Governor Christine Lagarde suggested that the strategic review provided a “Europe” implementation of the same idea. However, there is a big difference between stating that inflation above the target is aggressively required and simply accepting it as a risk after a period of undershoot. The difference is now reflected in wages and the behavior of pricers.
JP Morgan’s Greg Fuzesi contributed to this article
ECB Strategy Review is a Missed Opportunity
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