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The ECB’s strategy review revealed
On 08 July, the ECB announced the main conclusions from its review of its monetary policy strategy. GianLuigi Mandruzzato and Stefan Gerlach outline the eight main points.
- The ECB will continue to measure inflation using the Harmonised Index of Consumer Prices (HICP). This offers continuity with the current framework.
- The cost of owner-occupied housing will be incorporated in the analysis to capture inflation as perceived by households. This is an important part of the cost of living but not part of HICP inflation. Unfortunately, there is a lack of timely data that makes it difficult to assess in (almost) real time. The ECB will rely on estimates of these costs and will include them in its wider set of inflation indicators. One potential problem is that if housing costs diverge sharply from HICP inflation, there is a risk that it will add confusion to the monetary policy outlook.
- The new inflation target is symmetric around 2%. The previous target was for inflation “below but close to 2%”. The need to keep inflation below 2% led the ECB to refrain from policy measures that risked pushing inflation above 2%, which led to too low inflation.
- If interest rates fall close to the lower bound, policy must be particularly forceful and may lead to inflation being temporarily above the 2% target. The perception that inflation outside a 0-2% range is unacceptable is now gone.
- The unconventional monetary policy tools used during the crisis will remain part of the ECB’s toolkit and can be relied on to be used rapidly again if necessary. In the past, there was an apparent pecking order of policy measures, of which QE was the last. Thus, only when all other options were exhausted did the ECB adopt it. That meant that the ECB was too slow to react to the worsening euro area economy.
- Climate factors will be incorporated into the framework. The ECB will adapt its disclosures, risk assessments, corporate sector asset purchases and the collateral framework to include climate factors. This is likely to have little impact on the ECB’s conduct of policy and its effectiveness but may have important consequences for the structure of its balance sheet and relative rates of return on financial assets.
- The communication of policy decisions will be enhanced. The monetary policy statement will be streamlined and made clearer.
- The ECB will perform regular reviews of its policy framework, with the next scheduled for 2025.
An unspoken objective of the review was no doubt to remove various constraints on the ECB’s ability to stimulate the economy sufficiently to raise inflation to the target. While the changes announced are seemingly small, their overall effect is likely to allow for that in several ways.
First, it is now possible for the ECB to use unconventional monetary policy tools immediately if a sharp contractionary shock occurs. The delayed reactions of the ECB to the global financial crisis and the eurozone debt crisis are therefore unlikely to be repeated.
Second, the symmetric 2% target will allow for more symmetric policy responses. The ECB started in 1999 with a 0 – 2% definition of price stability, its primary objective. In 2003 it was clarified to say that the objective was “below, but close to, 2%”. While that statement was never clarified, many commentators interpreted it as saying that the target was around 1.8%.
Since inflation is not perfectly controllable, the fact that the central objective was close to 2% meant that policy makers were unwilling to adopt policies that were likely to return inflation to 1.8% but risked pushing inflation above 2%. The ECB therefore hesitated to adopt more stimulus when inflation reached somewhere around 1.5%. The result was endemic low inflation.
Since the target is now symmetric and 2%, the ECB is more likely to pursue stimulatory policies even if inflation approaches 2%. That suggests inflation will be a little higher on average in the future than in recent years.
The next Governing Council meeting on 22 July will be the first under the updated monetary policy strategy and will offer an opportunity to assess its implications on the conduct of monetary policy in practice.