The European Central Bank has long stood out among the ranks of the world’s central banks for its hawkish tilt. The central bank’s mandate for price stability — enshrined in international treaty — was interpreted as calling for inflation to remain close to but below 2 per cent. The result of the ECB’s strategy review, the first since 2003, is a modest but welcome update, helping not only to make the institution more conventional but to make its goals far clearer.
The publication of the review represents the next step in breaking with the conservative monetary policy of the Bundesbank, the German central bank, that was imported into the institution. The ECB will now have a symmetric inflation target; inflation that is either below or above 2 per cent will be “equally undesirable”, in president Christine Lagarde’s words. Additionally, the central bank will tolerate a transitory period of “overshooting” if a sustained period of near-zero interest rates threatens the central bank’s credibility in hitting its inflation target.
As well as having the merit of being clearer, the new target jettisons the central bank’s hawkish bias. This makes sense. The ECB has consistently undershot its inflation target since the 2008 financial crisis. In fact, the eurozone has often flirted with deflation, an indicator of the extent of excess unemployment and insufficient investment in the single currency area. A more aggressive approach — the central bank was one of the last major institutions to embrace quantitative easing — might have led to a stronger and more robust recovery. On Thursday, Lagarde said new, unconventional tools such as QE will remain part of the ECB’s armoury.
The shift is less radical than many expected, however, and certainly does not represent an overhauled approach to monetary policy. Unlike the Federal Reserve, the ECB will not target “average inflation”, allowing prices to rise faster to compensate for past shortfalls. The change to include housing in its chosen measure of inflation is limited to the “cost of owner-occupied housing” — which usually changes only modestly year-to-year — rather than actual house prices. A “climate action plan” was no more extreme than checking that companies from which it purchases bonds were acting in line with the goals of the Paris climate accords.
This may be the price of consensus. The review was completed two months faster than planned — probably indicating the absence of strong disagreements among the governing council that includes the heads of eurozone national central banks. It may also be testament to Lagarde’s political skills — her predecessor Mario Draghi was often more explicitly provocative to the representatives of the more hawkish member states.
Nevertheless, the politics of a more dovish framework is likely to be as difficult as the economics. A more active ECB has relied on the support of the German government: even when Draghi clashed with former German finance minister Wolfgang Schäuble, the Bundesbank, and members of Germany’s parliament during the eurozone crisis, he could count on the support of Chancellor Angela Merkel. The next chancellor is unlikely to have her standing or dominance of European politics but must, similarly, defend the institution’s independence.
Overall the package is an overdue step on the ECB’s journey to become a more normal central bank rather than a “Greater Bundesbank”. The changes to its target are modest and reasonable. They are, however, no substitute for meaningful action. The ECB now has a better target to aim for; whether it will be able to hit it is a different matter.