After the strategy review, the ECB walks on the tightrope of inflation


The European Central Bank is walking a tightrope on managing inflation expectations, with higher public spending in the euro area likely to drive annual price hikes towards, and possibly beyond, its new target ” symmetrical ”by 2%. This was the main message from Luis de Guindos, vice-president of the ECB, during an OMFIF briefing on July 12.

He pointed out how fiscal policy in the euro area – estimated to boost 4 percentage points in gross domestic product this year – was playing an “important role” in boosting underlying interest rates and inflation. . He warned of the need for fiscal consolidation once the pandemic is over.

Although headline inflation in the euro area is expected to reach 2.9% by the end of the year, underlying and headline rates are expected to fall back to 1.4% in 2023, mainly reflecting weak labor markets. More forcefully than other ECB policymakers, de Guindos has pointed out the possibility of a price hike generated by wage inflation from the fall if wage deals gain momentum. When asked if the ECB could join with other European central banks (such as the Netherlands) in supporting higher wage increases to help meet his inflation target, de Guindos replied that the ECB had not taken sides in the wage negotiations. “Forecasts can be right, but they can also be wrong, and forecasting inflation is particularly difficult due to globalization and potential supply chain blockages,” he commented.

De Guindos has been asked several times about the perceived inadequacy of the ECB’s asset purchase program to drive inflation to the desired rate. He indicated that regardless of the decision to end or extend the € 1.85 billion pandemic emergency procurement program at the end of March 2022, greater use of ‘unconventional’ instruments would be needed. He left open the question of whether a possible “post-pandemic purchasing program” could include flexibility in asset purchases across jurisdictions, durations and asset classes. It is a central element of the PEPP, even if it violates (exceptionally during the Covid-19 crisis) the fundamental principles of the ban on monetary financing of the ECB enshrined in the Maastricht Treaty.

According to an influential analyst at the July 12 session, “the ECB should show more commitment to a results-oriented policy linking its monetary policies to real inflation rates. Without this commitment, I fear that it will establish its objective without giving itself the means to achieve it and does not appreciate the need to increase its credibility by making commitments that are more concrete than nebulous.

De Guindos acknowledged that the tortuous conditionality of the ECB’s July 8 statement on the conclusion of its 18-month strategic review partly reflected the need to gain unanimity in its governing council, giving monetary conservatives more more weight than usual in the decision-making of the ECB. Far from specifically targeting inflation above 2% to compensate for the underestimation of the past 10 years, the ECB last week adopted cautious language bearing many characteristics of the German Bundesbank. The ECB has said it is “properly prepared and based on careful proportionality analysis” to take “particularly strong monetary policy action” if justified by “significant negative shocks” – which could “involve a transitional period during which inflation is slightly above the target ”. ‘

Like Christine Lagarde, President of the ECB, de Guindos did not wish to be frozen on timing. The ECB “would tolerate inflation exceeding 2% depending on the circumstances”. Stressing that eurozone interest rates have been held for years at their lower limit, he refused to rule out a further cut in negative rates. The need for asset purchases would continue as the line blurred between conventional and unconventional tools.

Asked about the unity of the board of directors, de Guindos countered that “price stability is the agreed objective for the 25 members”. The ECB would continue to support economic policy. “Even if we will see a recovery from the pandemic, there will still be risks and it is fragile. The unemployment rate will only become clear after the phasing out of government employment assistance. ‘

Along with criticism from some commentators that it needs to increase inflation with more force, the ECB has faced complaints that it should take near double-digit increases in broad money supply more seriously. Juan Castañeda, director of the Institute for International Monetary Research at the University of Buckingham, an inflation “hawk”, stressed the inconsistency of the ECB’s monetary analysis. While maintaining the “monetary pillar” in its strategy, the ECB – as Guindos did on July 12 – downplays the relationship between broad money growth and inflation. “This hampers the predictability of the ECB’s policies,” Castañeda said, “as well as its focus on maintaining price stability. This regardless of whether or not we agree on stronger or stronger inflationary trends. weak. ‘

On the delicate issue of the creation of a banking union, de Guindos offered his support for the development of a European deposit guarantee system. He said it was “not good news” that the latest attempt to seal a deal failed last month. He underscored a cautious approach to building a digital euro, citing problematic repercussions on financial stability. A digital currency issued by the central bank could deprive banks of deposits and seriously undermine their business models, he added.

David Marsh is President and Ellie Groves is Executive Director, Economics and Monetary Policy Institute, OMFIF.

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