There’s nothing wrong with one central bank implementing the policies of another central bank. However, we can only promote such when the action equates to “less interventionism,” bringing us closer to free market solutions. If it requires more, as the European Central Bank (ECB) has demonstrated with an introduction to its new framework on Wednesday, it is a bad move.
The Fed last updated its framework in 2012. Yet the ECB has not conducted a strategy review since 2003. In her presentation of the “preliminary considerations” of her policy review, the president of the ECB, Christine Lagarde noted concerns of persistently “low inflation,” citing that “annual inflation averaged 2.3%” between 1999 to 2008, “but only 1.2%” a year between then and 2019. It seems Europe has not had the highly sought-after increase in the cost of goods and services for over a decade either. Given the low inflation environment and change in consensus, which governs monetary policy worldwide, Lagarde believes it’s the appropriate time to similarly update the ECB framework.
Naturally, this was not without some forethought. Like the Fed who did multiple Fed Listens events in advance to consider ideas from a broad range of groups, the ECB launched an ECB Listens program to
hear from a wide variety of stakeholders – including citizens, academics, parliamentarians and civil society organisations – about how they perceive our goals and actions.
These “listening tours” by policymakers—and not just central bankers—usually have the stench of insincerity about them, and it’s a fairly safe bet that all this listening won’t include much listening to those who champion the free market or voice opinions in opposition to the general zeitgeit at central banks.
Meanwhile, however, we were offered some direction as to where the ECB intends to push monetary policy this decade. Like the Fed, they may move toward an “inflation overshoot” objective:
The wider discussion today, however, is whether central banks should commit to explicitly make up for inflation misses when they have spent quite some time below their inflation goals.
The notion of inflation overshoot seems to have come out of the proverbial left field. It is still very new. So she proceeds with caution:
If credible, such a strategy can strengthen the capacity of monetary policy to stabilise the economy when faced with the lower bound. This is because the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates.
It is not explained how the “promise” of an inflation overshoot raises inflation expectations, which in turn lowers real interest rates. Nor is the link very intuitive as it’s the central banks that openly manipulate interest rates through rate setting and bond-buying programs. This might be why she goes on to urge: “the usefulness of such approach should be examined,” considering that
make-up strategies may be less successful when people are not perfectly rational in their decisions.
Of course, inflation cannot be mentioned without a nod to the Phillips curve, the tradeoff between inflation and unemployment. According to the ECB, the Phillips curve still exists but is not working at the moment.
ECB research suggests that the empirical Phillips curve remains intact, but it may be rather flat.
The ideas expressed by Lagarde don’t appear to stray far from those of Powell, the main difference being that she is not entirely sold on the idea of inflation makeup strategies. She concludes by asserting central banks can only be credible if the general public understands what they are doing and why, and that they must talk to people whom they “do not normally reach.”
Perhaps there’s hope yet. After all, can a serious economic discussion about monetary policy truly be had with no mention of the benefits of unhampered markets or any future move away from interventionism? Any discussion devoid of this amounts to more policy to correct the problems of past policy, a strategy which only appears to cause a never-ending cycle of continuous policy interventions.
