ECB plans to copy the Fed in changing the inflation target

The ECB could allow inflation to go above target

The ECB could allow inflation to go above target.

The president of the European Central Bank (ECB), Christine Lagarde, has shown on Wednesday an outline of what the future of monetary policy in the euro zone may be. At a conference in Frankfurt, Lagarde acknowledged that the agency is considering adopting a new approach when looking at inflation, as the Federal Reserve (Fed) has already done.

The world has changed, Lagarde acknowledges, and the ECB must adapt to these changes. This forces the body to review the way in which it measures price stability and, probably, to open its hand to more inflationary pressure before being forced to remove stimulus and tighten its monetary policy.

“The formulation of our inflation objective [2%, or slightly below the 2% that the presidents of the ECB always repeat] was appropriate when the main concern was that inflation would skyrocket,” Lagarde said.

But the current world is not inflationary, if not the opposite, and this will lead it, as it has already done with the Fed, to change the way in which inflation and price stability are analyzed. “In the current context of low inflation, we have several concerns that should be reflected in our inflation target. It is increasingly important that we ensure that we have enough room to be able to push through conventional monetary policy,” Lagarde explains.

Thus, the ECB does not want to have its hands tied, and is evaluating formulas to allow inflation to exceed 2% without being forced to raise rates and stifle the recovery. One way is to take into account the average inflation that has taken place in a longer period of time than you are looking at now.

The ECB is evaluating formulas to allow inflation to exceed 2% without being forced to raise rates and stifle the recovery. “The big discussion now is whether central banks should commit to balancing the moments in which inflation has spent some time below its target,” he stressed, and believes that “this strategy can strengthen the capacity of monetary policy to stabilize the economy at a time when inflation is at its lowest point. “

New way to measure inflation

In addition to possible changes in the inflation target, Lagarde also opens the door to variations in the way it is measured, including imputed rents, a measure that Luis de Guindos, vice president of the ECB, already put on the table last month of June.

“Our economies are changing faster and faster. We need to closely follow the general inflation concepts that capture the costs that people face on a day-to-day basis, including the imputed rent measures,” Lagarde explains.

That is, to include in the CPI the evolution of the prices that an owner would pay for their home, something that does measure inflation in the United States.

Lagarde also wanted to highlight the importance of the ECB taking into account the evolution of inflation without gasoline and without fresh food, the most volatile components of the basket: “To have a better perception of the evolution of the CPI in the middle term, we must complement our analysis by also looking at the less volatile measures, such as core inflation, “he explains.

Extraordinary measures will become ordinary

Once the issue of inflation has been settled, Lagarde wanted to emphasize that, what until now have been considered “extraordinary measures” by the central bank, from now on will have to be assumed as one more tool within normality.

“Since 2009 it has been assumed that normalization meant returning to the policy of using interest rates, and eliminating unconventional policies,” Lagarde highlights, “but if normality is similar to what we saw just before the pandemic and, I I’m afraid, what we’re seeing today, we have to be prepared. “

Dealing with levels of public debt

Another issue that the ECB is assessing and on which it is already working within the framework of its strategic review, is how to fit in a world in which public debt is skyrocketing in the euro zone and other parts of the world, in which economic policy measures increasingly interact and are more closely linked to monetary policy.

“Fiscal and monetary policies are interacting ever more closely, and this raises important questions, which will be even more serious when the pandemic ends. These include how to conduct monetary policy in a world of permanent high levels of public debt, and the most appropriate design of the fiscal framework in Europe “, said the president.

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