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ECB: strategic review = battle of monetary doctrines

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Bruno Cavalier
Chief Economist at ODDO BHF

Christine Lagarde has launched an audit of the ECB’s strategy. It will primarily focus on the inflation objective (price measurement, definition of the target, instruments to achieve it). Other topical issues will be examined, such as the greening of monetary policy, but they will remain peripheral. This audit will provide an opportunity to compare two doctrines. The first, in line with the Bundesbank, is critical of current policy and seeks to adopt a target band, e.g. 1.5%-2%. This would minimise the deviation from the target and prepare for a tightening. The second will strengthen the symmetry of the 2% target, which justifies maintaining an accommodative policy. The second approach is in the majority and will likely remain so, in our view. 

How to measure inflation? How to target inflation?

The Treaty on the Functioning of the EU (TFEU) sets the primary mandate of ECB as ensuring "price stability" and, as secondary tasks, provided that the primary mandate is fulfilled, assisting in the implementation of the European Union’s economic policies. The TFUE does not define price stability. In a literal sense, one could say that this is equivalent to zero inflation, but this is not how the ECB, or any other central bank in the world, envisages it. Price stability in a situation in which the decisions of economic agents are considered to be little or not at all affected by price developments. There are various ways of translating this into numerical terms. 

  • In 1998, when it was established, the ECB had retained an increase in the eurozone’s Harmonised Index of Consumer Prices (HICP) of under 2% per annum.
  • In 2003, following a first strategic review, the ECB clarified that the aim was to maintain the annual inflation rate of the Eurozone below the 2% threshold but close to this level in the medium term.
  • In 2020, another strategic review will be conducted as confirmed today by Christine Lagarde following the Governing Council meeting. The main focus will be on assessing the framework within which monetary policy is conducted, the ECB's inflation target and how it is measured, and the instruments employed. The secondary focus of the audit will be assessing other issues that may have an impact on how monetary policy is conducted, such as the greening of the economy. In the present note, the focus is solely on inflation-related issues. There are two aspects to consider, one fairly technical about how inflation is measured, the other, more fundamental, about defining the inflation target.

The following two charts are a useful introduction to the problem as they illustrate the gap that can exist between the measurement of inflation (according to the best available statistical techniques) and household perception of inflation. 

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