Friday, January 28

The ECB raises its inflation target to 2% to gain room for action

Christine Lagarde, president of the Central European Bank (ECB).

Christine Lagarde, president of the Central European Bank (ECB).

The European Central Bank (ECB) plans to announce this Thursday the result of the first review of your strategy of monetary policy since 2003 that according to ‘Bloomberg’ reported late on Wednesday, will include a higher inflation target, as expected. Thus, the goal will become 2%, instead of the now classic “lower, albeit close” level 2% in the medium term. In addition, the monetary authority will be left “room to surpass it when necessary, “according to the agency. All this implies that the body chaired by Christine Lagarde grants itself more scope for action.

Unlike the Federal Reserve the United States, the ECB’s mandate is limited to control inflation and not to also promote job creation or growth. Despite this, since the arrival of Mario Draghi to his presidency in 2011, the European body carried out a flexible interpretation of its obligations to avoid the breakdown of the euro, an objective in which it was undoubtedly successful.

To do this, yes, he was forced to take unprecedented measures such as wearing the types to negative, inject massive liquidity to banking and launch multi-million dollar programs purchase of public and private debt, which caused internal clashes between the minority ‘hawks’ (supporters of an orthodox and limited monetary policy, with Germany at the head) and the so-called ‘doves’ (favorable to go as far as possible within the legal limits of action) , in addition to some judicial complications always resolved in favor of the monetary authority.

With a higher inflation target and one that also allows prices to temporarily exceed it, the ECB gives itself more capacity to act with conventional measures (rising and falling rates) and unconventional (basically the rest) in deflationary situations, as in the second part of the Great Recession, or of temporary rise in prices in full crisis, as is currently the case. Despite the current rise in inflation, the agency maintained its exceptional measures against the pandemic in June and is expected to begin discussing its progressive withdrawal after summer. According to their forecasts, the CPI will average 1.9% this year, may reach 3% by the end of the year, and will subsequently drop to 1.5% in 2022 and 1.4% in 2023.

Define stability

European treaties mandate the ECB to ensure that there is price stability in the euro zone. The key is how you define that stability. In 1998, at the same time that the institution was created, the central bank of the euro interpreted it as that inflation is below 2%. As it was too ambiguous, in 2003 it specified that it should be “below, but close” of that level. In January of last year, it launched the first review of the monetary policy strategy in 17 years, which it expected to have completed in November or December but whose results have been delayed due to pandemic. “The situation has completely changed” since 2003, Lagarde justified then.

The central bank justified the review by the “downward trend of growth” that has been taking place since 2003 due to structural factors (population aging, drop in productivity) and conjunctural factors (Great Recession), which have caused a drop in natural interest rates, reducing the margin of central banks to combat crises only by lowering the official price of money and forcing them to unconventional measures such as the purchase of debt.

“It is different,” he argued, to deal with high inflation, as has happened historically, than a low one. “The threat to environmental sustainability, rapid digitization, globalization and the evolution of financial structures have also transformed the environment in which monetary policy operates, including the dynamics of inflation,” he added in a note.

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