Global Policy Institute Comment on the 2020 report to the European Parliament on ‘Options for the ECB’s Monetary Policy Strategy Review’

This report [1] by Yvan Lengwiler and Athanasios Orphanides was commissioned by the ECON committee of the European Parliament as part of the 20-year review of the European Central Bank (ECB). Our initial comments are based principally on the Executive Summary and Recommendations of the Report, and made in the light of the Global Policy Institute’s own submission to the ECB review[2].

Executive Summary (ES) Comments

The ES suggests that:

“The ECB pursued a policy of low inflation that unnecessarily restricted growth and employment below what could be achieved without compromising price stability. In addition, ECB policies contributed to a sharp macroeconomic divergence within the EMU, a continuing source of fragility”.

This comment applies to the post-GFC period from 2008 to 2013 when Trichet was ECB President and interest rates were raised unnecessarily and monetary policy tightened. The GPI Report makes the same point. Subsequently under Draghi the policy became expansionist.

The ES argues that:

The prohibition of monetary financing and fiscal transfers, in particular, has been invoked to challenge ECB policy. We find that the ECB has the independence and authority to fulfil its mandate better, but has been too timid to use its power, owing to an overcautious interpretation of these prohibitions”, and later that:

“The ECB can address this issue by making more effective use of its authority under Article 18 of the Statute of the European System of Central Banks and of the European Central Bank”.

These points, however justified in monetary policy terms, have been challenged, though, so far, the current ruling of the ECJ appears to support them, albeit with caveats.

The ES argues that:

“Adopting a 2% inflation goal the soonest would re-anchor inflation expectations and improve the ECB’s ability to promote growth and employment without prejudice to price stability, in accordance to its mandate”

This suggestion ignores the need to provide – as the GPI Report does – a proper definition of price stability. It still equates the objective of price stability – which should be defined as a ‘constant price path’ – with a target of a rate of inflation. The reasoning supporting the Lengwiler and Orphanides position is based on the argument that a) a fixed 2% inflation rate anchors inflation expectations, and b) it is a “global standard” for central banks.

This wider Lengwiler and Orphanides argument ignores to potential for other anchoring of expectations, e.g. to nominal income as in the use of Nominal GDP (NGDP) targeting. The position taken also ignores concerns about the theoretical modelling arguments supporting the rate of inflation as such an anchor.

For instance, the 2015 Brookings survey study by Kumar et al [3] on the New Zealand and US experience of firms and households, cast doubt on the validity for other than professional forecasters, though even here there is doubt, see Corsello et al [4]. The Kumar study points up the problem of econometric models not being able to encompass heterogeneous behaviours across the public in terms of inflation expectations. It is worth noting that the case of New Zealand is instructive, given its long-standing use of inflation targeting, i.e. from 1989, with increases which have not noticeably improved the position.

The ES suggests that:

“The ECB can have a significant effect on the relative financing cost of green technology. This should be considered in the broader context of the substantial spending power of the ECB. This choice is political in nature and outside the scope of the ECB’s authority”

This position is similar to the GPI position and can be agreed.

Comments on Recommendations (R)

R.1 and R.2. These both relate to the advocacy in the ES of a fixed 2% inflation target, but with symmetry above and below. The GPI view, as stated in our Report, is that the NGDP targeting would achieve the aim of the symmetrical targeting, but in a more efficient, effective, and communicable manner.

R.3 The ES argues for the ECB to support greater economic cohesion across the EZ. The GPI agrees, but the cohesion itself is primarily an issue of ‘economic governance’, the subject of the EC’s own Review in this policy area.

R.4 on “other objectives” has been covered above in relation to ‘green targeting’, the GPI supports the view in the ES

R.5 on the “permanence of ECB measures”, GPI has no problem with this recommendation, but it is not clear that it is necessary.

R.6 on the ECB providing principles for the rating of collateral to avoid reliance on outside credit ratings. GPI has no problem with this idea, but it may not be as practicable to implement as suggested.

R.7 on the ECB avoiding reliance on market valuations of debt is an interesting idea, and the problem of self-fulfilling equilibria is a problem. How practicable? is a question GPI would again ask.

R.8 on the issue of publishing the monetary and economic projections of Governing Council members, GPI supports the publication to increase transparency, but there is the danger of mixed messaging.

R.9 the view is expressed in the ES that as a means of clarifying the purpose of the Assets Purchasing Policy, and to avoid the suspicion of “monetary financing”, the size of the Bank’s balance sheet could be adjusted in response to changes in the inflation outlook as a useful indicator of the “systematic nature” of ECB policy. The GPI view is that publication of yet another indicator would serve only to add to the complexity of communication and would do nothing to allay fears of monetary financing for those who believe it to be a danger.

R.10 The ES suggests that the ECB has allowed the appearance of its attempting “to enforce fiscal discipline”. GPI sees no real evidence that this is the case and the recommendation appears superfluous at best.

R.11 The ES suggests that there is too much secrecy about its policy deliberations and recommends publication of Minutes, etc. of meetings. GPI agrees with this recommendation as good practice.

R.12 The ES suggests regular 5-yearly Policy Reviews. The GPI agrees with the suggestion of regular reviews.

Concluding Comment

The Lengwiler and Orphanides Report provides a valuable and detailed orthodox examination of the economic and monetary background of the EZ from 1999, and the varying ECB (and other central bank) policy approaches deployed during the period from 1999. However, – despite making some useful specific recommendations – the report represents a missed opportunity to provide a radical investigation of the purpose, intrinsic operation, and validity of the ECB’s current monetary policy. The principle reason is that the authors have refused to contemplate departing from contemporary monetary policy orthodoxy and hence to acknowledge the inability of monetary policy to take over the role which should be played by fiscal policy (and other supply-side economic policies) in growing the economy. Monetary policy, to be sure, has an important role to play in stabilising the financial sector, especially banks, and in ensuring that there is always sufficient liquidity, in the banking sector. Monetary policy should also align itself with fiscal policy by targeting, as GPI has suggested, GDP. But coordinated fiscal policy and structural supply side policies are also required, party to deal with the ‘neutral technology’ investment and low real wages which has been a secular problem over the past 2/3 decades. To ask monetary policy to go beyond that a narrow remit is the fundamental error of our times.

Notes

[1] Yvan Lengwiler and Athanasios Orphanides ‘Options for the ECB’s Monetary Policy Strategy Review’,  a study  requested by the ECON committee of the European Parliament, Policy Department for Economic, Scientific and Quality  of Life Policies Directorate-General for Internal Policies 652.753  September 2020, available at: https://www.europarl.europa.eu/RegData/etudes/STUD/2020/652753/IPOL_STU(2020)652753_EN.pdf

[2] ‘The European Central Bank’s Mandate: Perspectives on General Economic Policies’, Global Policy Institute, report submitted to the ECON’s secretariat of the European Parliament, September 2020. See Summary ‘Global Policy Institute Report to the European Central Bank Review’, available at: https://gpilondon.com/gpi-news/gpi-response-to-the-european-central-bank-review

[3] Saten Kumar, Hassan Afrouzi, Olivier Coibion, Yuriy Gorodnichenko ‘Inflation Targeting Does Not Anchor Inflation Expectations: Evidence from Firms in New Zealand’, Brookings Papers Fall 2015, available at: https://www.brookings.edu/wp-content/uploads/2016/07/PDFKumarTextFallBPEA.pdf

[4] Francesco Corsello, Stefano Neri, Alex Tagliabracc ‘Anchored or de-anchored? That is the question’,  Centre for Economic Policy Research, November 2019, available at: https://voxeu.org/article/anchored-or-de-anchored-question

 

About the GPI

The Global Policy Institute is a research institute on international affairs. It is based in the City of London, and draws on both a rich pool of international thinkers, academics as well as policy and business professionals. The Institute gives non-partisan guidance to policymakers and decision takers in business, government, and NGOs.

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