PARIS — Here’s a bright idea: Since the European Central Bank has struggled for years to reach its inflation target, why not change the target?
To be sure, the idea is nowhere near ECB President Mario Draghi’s agenda, but the persistently low level of inflation in the eurozone has prompted some economists, bankers and policymakers to wonder whether that might not be worth considering — while other voices are arguing against it.
At the core of the suggestion is the idea that globalization and technological innovation have changed the very nature of inflation. As summed up by Daniel Gros, director of the Center for European Policy Studies, these forces pressure production and distribution costs and bring universal competition to everyone’s doorstep. Central banks, the reasoning goes, keep fighting 21st-century inflation with 20th-century concepts and tools.
Central bankers, off mark
Just before the euro’s creation in 1999, the nascent ECB decided that its treaty-enshrined mission to maintain price stability would mean that inflation should be kept below 2 percent “over the medium term.” A few years later, in 2003, the ECB’s governing council clarified that the target meant that inflation, while below, should also be kept “close to” the 2 percent target.
Mario Draghi, president of the European Central Bank, speaks to the media on December 14, 2017 in Frankfurt, Germany | Thomas Lohnes/Getty Images
The last time the ECB met its target was in 2012. In most recent years, it has missed the target by a wide mark. The preliminary estimate of inflation in December 2017 released on Friday shows that prices rose by only 1.4 percent on an annual basis, according to the EU’s statistical agency, Eurostat.
That’s in line with the ECB’s own forecast, which saw inflation at 1.5 percent for all of 2017, with moderate energy prices and notably, subdued domestic wage increases. Looking ahead, the central bank is still nowhere near fulfilling its one and only mission. Inflation is even expected to decline this year — to 1.4 percent, then rise slowly in 2019 (1.5 percent) and in 2020 (1.7 percent).
By then, it will amount to eight full years of ECB failure on the inflation front.
That should in theory dampen the arguments of the most “hawkish” wing of the ECB’s governing council, which has long opposed Draghi’s loose monetary policies designed to boost both inflation and growth in the eurozone. But when there’s a will to argue, there’s always a way. The case now is that loose monetary policies should be dropped because the aim is elusive.
Considering that the ECB, among other central banks, is unable to reach its inflation target, some argue that it should either drop the target implicitly and stop bothering, or formally declare that its target is now, say, 1.5 percent or even 1 percent. In 2015, Axel Weber, the former president of the German central bank, even said central banks should drop the targeting of inflation altogether because in the modern world, the price index has become an imperfect way to measure an economy’s performance.
However, the arguments for lowering or scrapping the ECB’s inflation target, while academically interesting, run against powerful political and financial realities.
The first is that on the dovish side of the monetary policy debate, some have counter-argued that since the ECB wants to be judged on the “medium term,” it should now shoot for a higher target to make up for the shortfall in the low-inflation years.
In a widely debated paper in 2010, Olivier Blanchard, a former chief economist of the International Monetary Fund, proposed that Western central banks — which all go by the 2 percent target — should raise the goal to 4 percent. Blanchard argued that this would give central bankers more flexibility to act before they reach the “zero lower bound” on interest rates.
In the U.S., the academic debate seems to be picking up again, after a group of influential economists of the neo-Keynesian persuasion wrote a letter last June to head of the Federal Reserve, Janet Yellen, to argue for raising the inflation target. “Economies change over time,” they wrote, noting that the current 2 percent straitjacket prevents the U.S. central bank from aggressively promoting growth.
Another powerful argument against changing the target all comes down to the question of central bank credibility. “We build all our policy on the inflation target, financial markets plan and anticipate accordingly, trillions of dollars are moving each year on our decisions, and some would want us to move the goal posts? I don’t see that happening,” said an ECB insider.
At the very least, nothing is likely to happen as long as central banks the world over are still fighting the consequences of the Great Recession and the sovereign debt crisis — and remain some ways from business-as-usual monetary policy.
“I don’t see Western central banks diverging widely on this, with some aiming for 4 percent inflation and others 1 percent,” the ECB insider argued.
“Down the road, we may have grounds to think hard about the changes in the global economic landscape and adjust our definition of price stability accordingly, how and when to adjust it and under which procedure,” he added. “But now would be a terrible moment to do that.”