Meinung

The ECB’s New Framework: The Bright Spots Are in the Grey Areas

The new monetary framework presented by the European Central Bank has disappointed many observers. The critics are wrong. The new framework is a great improvement.

Stefan Gerlach
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ECB policy statements are rarely an easy read. It is easy to see why: With often sharply conflicting views among the members of the Governing Council, they unavoidably must be bland to be agreed by all. The new monetary framework announced a little more than a week ago is a case in point.

But it would be wrong to downplay the document. The bright spots are in the grey areas. Much has changed.

Those that are not enthused by the new framework make two points. They note that the distinction between an inflation target of «below but close to 2%» and a target of 2% is hair thin. It is hard to believe that raising the inflation objective by something like 2/10th of a percent will matter at all, since the ECB has failed miserably in recent years to reach the objective and maintain inflation at that level.

And they stress that the introductory statements to the press conferences have often stated that the inflation objective is symmetric. Thus, to them, the new framework merely formalises something that has been acknowledged for a long time.

But that is too dim a view to take. In the case of the ECB, it is important what is not banned. And here the document is crystal clear: inflation temporarily above 2% is now acceptable.

The ECB naturally erred on the side of caution

The history of the ECB’s inflation objective explains why that changes everything. In a moment of self-flagellation in 1999 the ECB defined price stability as inflation between 0 and 2%. That is a wide zone that lacked a focal point. To add clarity, in 2003 it explained that it would aim for inflation of «below but close to 2%». But the sense remained that inflation above 2% would be unacceptable.

Inflation is hard to control exactly. Energy or food price increases, or policy changes being unexpectedly powerful, can easily give it a jolt. Since a small overshooting of the target risked being seen as sign of failure, but a large undershoot would not, the ECB naturally erred on the side of caution.

More so since «below but close to 2%» was undefined. No doubt some members of the Governing Council felt that 1.5% or 1% or even 0.5% was close enough. That led to a lack of commitment to achieving the objective. The asymmetry of the target and the lack of shared understanding what «close to» meant in practice have resulted in an average inflation rate since 1999 of 1.4%.

Over- and undershoots are equally undesirable

The new framework changes that. The increase in the inflation target to 2% matters little. But the fact that inflation temporarily above that level is acceptable is important. The ECB is now much better able than before to pursue the target since over- and undershoots are equally undesirable.

It is of course true that the notion of a symmetric target is not new. But it has now been given much firmer grounding. The ECB President is required to speak on behalf of the Governing Council. Her views in the introductory statement should be seen as her best judgement of the balance of opinion within the Governing Council. It expresses her assessment of ECB practise.

But it is not a statement of ECB policy that binds the members of the Governing Council. For it to do so, a formal agreement by the Governing Council is needed. The new framework solves that problem and makes it much more likely that the ECB will act symmetrically in the future. Again, the change appears cosmetic but is in fact important.

Unconventional measures becoming conventional

Little attention has also been paid to the ECB’s unconventional policy measures becoming conventional – they are now part of the standard framework. That may be unsurprising as the ECB was quick to adopt the Pandemic Emergency Purchase Programme when the Covid pandemic struck. But was not at all clear that it would actually do so.

A repeat of the situation after the Global Financial Crisis was possible. Back then, the ECB seemed to have a pecking order of policies, with asset purchases last. That required it to work it is way down the list, only adopting Quantitative Easing when it was clear that all other policies were insufficient.

That led to a slow response, which caused sentiment to worsen and aggravated the problems. The new framework lets the ECB adopt forward guidance and asset purchases immediately in response to a downturn, even in a situation in which interest rates are not at the lower bound.

Overall, the new ECB framework raises the inflation target trivially but makes it easier for the Governing Council to pursue it. And it makes more rapid deployment of previously unconventional monetary policy tools possible. It is a great improvement.

Stefan Gerlach

Stefan Gerlach is Chief Economist at EFG Bank in Zurich and served as Deputy Governor of the Central Bank of Ireland in 2011-2015. Since earning a doctorate in Geneva in 1983, his career has bridged academia and central banking. He has been Professor of economics at the Goethe University in Frankfurt, an External Member of Monetary Policy Committee of the Bank of Mauritius, and Chief Economist at the Hong Kong Monetary Authority. Before joining BIS as a staff economist in 1992 he was an academic in the US.
Stefan Gerlach is Chief Economist at EFG Bank in Zurich and served as Deputy Governor of the Central Bank of Ireland in 2011-2015. Since earning a doctorate in Geneva in 1983, his career has bridged academia and central banking. He has been Professor of economics at the Goethe University in Frankfurt, an External Member of Monetary Policy Committee of the Bank of Mauritius, and Chief Economist at the Hong Kong Monetary Authority. Before joining BIS as a staff economist in 1992 he was an academic in the US.