{"id":1235,"date":"2018-07-18T18:52:12","date_gmt":"2018-07-18T18:52:12","guid":{"rendered":"http:\/\/euromenaenergy.com\/?p=1235"},"modified":"2018-07-18T18:52:12","modified_gmt":"2018-07-18T18:52:12","slug":"time-to-untie-the-ecbs-hands","status":"publish","type":"post","link":"https:\/\/emimer.com\/?p=1235","title":{"rendered":"Time to untie the ECB\u2019s hands"},"content":{"rendered":"
\n

By Stefan Gerlach\/Zurich<\/p>\n<\/div>\n

The European Central Bank\u2019s recent announcement that it will try to end asset purchases by this December means that it has confidence in its ability to achieve price stability.
\nBut those who decided that price stability should be the ECB\u2019s single, overriding policy goal may have shot themselves in the foot, not least by denying policymakers much-needed flexibility.
\nThe ECB defines price stability as inflation \u201cbelow, but close to, 2% over the medium term.\u201d That is a lower inflation rate than even the Bundesbank achieved during its celebrated pre-euro history, and it is a tighter target than virtually all other central banks pursue.
\nFor some, too much of a good thing is apparently wonderful.
\nTo be sure, the ECB\u2019s definition of price stability was not a problem during the period between the global financial crisis and the adoption of quantitative easing, when inflation was well below 2%. To those who believed that monetary policy had been too tight, the ECB was right to do whatever it could to push inflation up toward the target range.
\nYet for those in favor of the ECB\u2019s \u201cstability-oriented monetary policy\u201d \u2013 a term suggesting that others disregard the risk of monetary instability \u2013 the price-stability objective has evidently become too constraining.
\nFrom their perspective, asset purchases never should have happened, and interest rates should have been raised long ago, despite the eurozone\u2019s too-low rate of inflation.
\nIt is safe to assume that those who hold this view were highly supportive of the ECB\u2019s hardline price-stability objective.
\nThey would contend that low interest rates raise financial-stability risks that grow more acute with time.
\nThat is probably true.
\nAnd yet it ignores the fact that raising interest rates prematurely can also fuel financial instability.
\nIn any case, the argument is moot, because the ECB\u2019s mandate rules out any rate increase that could conflict with price stability.
\nOf course, those in favor of higher interest rates would counter that inflation of 1% or even less is in fact \u201cclose\u201d to 2%, implying that price stability has been achieved and monetary policy can be tightened.
\nIn other words, they do not share the view that \u201cclose to 2%\u201d means something in the range of 1.7-1.9%. But this is a pernicious argument.
\nRunning inflation below the level debtors had reason to expect translates into high real interest rates, which in turn risks triggering defaults among borrowers, including mortgagors, firms, and governments.
\nUndershooting the inflation target is also dangerous because inflation expectations and interest rates will decline over time, which makes it more likely that the ECB will reach the zero lower bound when the next downturn occurs.
\nIt also increases the likelihood that asset purchases will become necessary once again.
\nThose in favor of a policy tightening would also note that low rates are problematic for savers, insurance companies, and pension funds, whose portfolios often include few equities.
\nBut nowhere does the ECB\u2019s mandate say that monetary policy should be set in the interest of savers or the financial industry.
\nAs a practical matter, the ECB\u2019s price-stability objective, originally designed to protect the eurozone from Italian-style inflation, has ended up protecting it from German-inspired deflation.
\nBut just because the ECB\u2019s mandate has forced it to do the right thing on occasion does not mean that we will be so lucky in the future.
\nThe global financial crisis required advanced economies\u2019 central banks to contend with circumstances that those who crafted their mandates scarcely could have imagined.
\nThe fact that things often do not work out as expected is precisely why central banks\u2019 objectives should be written to give policymakers flexibility \u2013 or poetic license to bend the rules \u2013 when extreme events occur.
\nOtherwise, policymakers will be less effective than they otherwise could be.
\nBecause the ECB\u2019s price-stability mandate is legally codified by the Treaty on the Functioning of the European Union, it cannot be altered without a treaty amendment.
\nBut the phrase \u201cbelow, but close to, 2%\u201d is the ECB\u2019s own, and thus can be changed with the stroke of a pen.
\nAs such, the ECB should consider two alterations.
\nFirst, it should get rid of the ambiguity inherent in the words \u201cclose to,\u201d by setting a point target to provide clarity to the public \u2013 and to ECB Governing Council members \u2013 about what its monetary policy aims to achieve.
\nWhether that target is 1.8% or 2%, or whether it is surrounded by a range, is less important.
\nSecond, the ECB must clarify how financial stability and business conditions factor into its policy decisions.
\nMany have argued that lengthening the policy horizon by precisely defining \u201cthe medium term\u201d would give policymakers room to pursue other objectives temporarily.
\nAfter all, because financial crises and deep recessions are deflationary, they, too, jeopardize price stability.
\nWith the ECB finally exiting the last crisis, now is a good time to reflect on what lessons it has (or should have) learned.
\nThe ECB must not delay in positioning itself for the next downturn. \u2013 Project Syndicate<\/p>\n

* Stefan Gerlach, former Deputy Governor of the Central Bank of Ireland, is Chief Economist at EFG Bank in Zurich.<\/p>\n","protected":false},"excerpt":{"rendered":"

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