Crises and cataclysms over two decades made European central bankers less inflation averse.
By Daniel Moss
July 8, 2021, 4:42 PM GMT+8 Updated on
The European Central Bank has discovered that a bit more inflation need not come with a health warning. While significant in the context of ECB history, the shift brings doctrine into line with real-world forces that officials have wrestled with since the euro’s inception.
Wrapping up the biggest strategy critique in almost two decades, policy makers agreed to raise their inflation goal to 2% over the medium term and regard misses on either side as equally undesirable. The decision is a departure from the previous target of “below, but close to, 2%,” which some officials felt was too vague. The step provides for inflation to go a little above the threshold during a “transitory period.”
The changes bring the 19-country bloc to a place that the Federal Reserve, Bank of Japan and others already occupy: a recognition that the pace of price increases was too slow in the aftermath of the global financial crisis and that it’s fine to indulge a bit of an overshoot. The idea is that it helps inflation settle in the vicinity you desire. For most central banks, there is a “2” somewhere in that target. By having more flexibility, officials theoretically have a freer hand to stoke expansions or respond to blowups and cataclysms. At the core of the ECB’s response to Covid-19 has been a 1.85 trillion-euro ($2.2 trillion) bond-buying program to hold borrowing costs at rock-bottom levels.
This isn’t an upheaval. In practical terms, the ECB has already evolved to the point where growth and stability have taken priority. Former ECB President Mario Draghi’s 2012 dictum of “whatever it takes” guides decisions today far more than the inflation aversion that was a hallmark of the German Bundesbank, once the most powerful monetary institution in Europe. (The ECB’s first chief economist, Otmar Issing, held the same position at the Bundesbank and helped guide the new organization in its infancy.) Draghi’s philosophy set the ECB on the road to where it is today.
Echoes of the Bundesbank and its reputation as a bastion of hard-money dogged the ECB in its early years. Top officials were seen as more worried about the level of the consumer price index than whether recession was on the way. Under its first president, Wim Duisenberg, the ECB was criticized for being too slow to cut rates during the 2001 downturn. He was derided for saying “I hear, but I do not listen.” In July 2008, two months before Lehman Brothers Holdings Inc. collapsed, the ECB raised rates. Then leader Jean-Claude Trichet said inflation was the euro zone’s top consideration. It’s unlikely that current ECB President Christine Lagarde or her successors would be so tone deaf, strategic overhaul or not.
The most seminal chapter in ECB history was written by Draghi, now prime minister of Italy. A succession of debt crises early in the ECB’s second decade raised the prospect of the euro zone fracturing, something Draghi and his allies thought would be catastrophic and a possibly fatal blow to the project of European political and commercial integration that characterized diplomacy since World War II. The whatever-it-takes commitment paved the way for the ECB to backstop debt and begin quantitative easing, albeit years after the Fed and BOJ. When Draghi retired QE in 2018, he emphasized the once unthinkable: ultra-loose policies are legitimate tools.
The overhaul codifies what had been de-facto for a while. Lagarde sought the strategic review soon after her appointment in 2019. As the only non-central banker to lead the ECB, she is well placed to discount the past, if not deny it. As head of the International Monetary Fund, Lagarde presided over a sprawling institution that shed the doctrine of austerity. As a former French finance minister, she is acutely attuned to the virtues of growth over inflation perfection.
The shift blesses an expansionary view of policy as economies try to re-open and inflation stirs from a low base. It buys the ECB time to see if price pressures are transitory or whether they are something more sinister and need to be thwarted sooner. This isn’t average inflation targeting, the outcome of the Fed’s own redo last year, but it drives policy actions in the same direction: lower for longer. Both central banks have been chastened by the experience of inflation’s failure to accelerate much after the GFC despite ultra-low rates and gains in employment.
It’s worth asking whether policy makers are too haunted by the past and whether the last decade is a good guide to the post-pandemic world. Unlike the years after the financial meltdown, global fiscal policy today is all-embracing, and monetary stimulus is being unleashed more aggressively. That might mean spurts in inflation aren’t transitory and become more persistent. It would be ironic if targets and goals were adjusted only to be of minimal use.
Critics have said that the ECB would never last but the euro and its guardian always manage to fight another day. Lagarde is now steering the ECB further from its Bundesbank-influenced roots.