by Dr Michael Lloyd
Michael Lloyd is Associate Director and Senior Research Fellow at the Global Policy Institute.
One of the first acts of Christine Lagarde when she became President of the European Central Bank (ECB) in 2019 was to announce a review of its Treaty Mandate and monetary policy operations, inviting submissions from outside. What follows is a summary of the main content and significant recommendations of the Global Policy Institute Report “The ECB’s Mandate: Wider Perspectives on European Union Monetary Policies” written in response to this invitation (click here for the Report in pdf format).
The GPI Report is radical in its approach, preferring to avoid an excessively narrow examination of the current monetary operations of the bank. The Report analyses the ECB’s policy in the context of an economic situation (pre-Covid) in which the bank found itself, as the only independent federal economic entity within the Eurozone, unable to deliver against its price stability mandate or generate adequate economic growth across the Eurozone.
Following a brief review of the evolution of the Eurozone economy and the shifting policy stance of the ECB since 2003, the Report considered the Mandate given to the ECB by the Treaties (TFEU and TEU). The Mandate – the achievement of ‘price stability’ could, we conclude, be better interpreted. Clearly the achievement of price stability as the objective set by the Treaty (TFEU) must of course be maintained. However, we define this objective as ‘the achievement of a constant price path over time’. This definition does not require further definition in terms of a specific inflation target. Separately, but subsequently, we define the appropriate target for the ECB to be ‘Nominal GDP’ (NGDP), or the money value of national income.
To confuse the distinction between the objective and the target is a ‘category error’ and has led to an insufficient and misleading definition of the price stability objective itself, as an inflation target. It matters not whether this is a single inflation target or a symmetrical inflation target, neither is appropriate. Of course, defining the price stability objective correctly as a constant price path over time, does not of itself necessarily mean that the target set should be NGDP, but it strongly supports the view that it should be.
NGDP-level targeting seeks to target a level of nominal GDP growing at the long-term potential growth of the economy, including an inflation target. For the EZ economy, that would mean keeping NGDP on a path that would grow at perhaps a rate of around 5%: a 3% long-run growth potential plus a 2% inflation target. The ECB would ease monetary policy when the level of NGDP is (expected to be) below the targeted path and tighten if it is (expected to be) above. Importantly, the rate of inflation would be allowed to fluctuate, without adjusting the interest rate up or down as suggested by the varying inflation rate. Instead monetary policy would be dedicated to maintaining the growth rate of nominal national income. Should NGDP fall below target in a particular year, the central bank would seek to make up for that in subsequent years.
In setting the NGDP as a single target variable we rejected the suggestion of a ‘dual mandate’, covering employment as well as inflation as targets, as highly problematic to manage. Instead both would be covered by the setting of the single target of NGDP.
By communicating an ECB target/policy rule to the general public that targets the nominal income of the average household the public will have a clearer view of the positive direction the monetary policy is trying to achieve. It will be in line with their own expectations of nominal household income growth over time – and not trying to target a higher inflation rate as something desirable. Were citizens to perceive this in their everyday understanding, it would improve the standing and the legitimacy of the ECB.
The various technical modelling innovations which the ECB has introduced indicate the flexibility of its approach to inflation targeting. But whatever has been accomplished in terms of attaining its inflation target, it has not as yet been sufficiently explained to the general public. The bank uses a variety of measures of inflation, specifically using ‘core inflation’ as its primary target, but only one – the HICP (Harmonised Consumer Price Inflation) – is widely reported, and used, for instance, in wage bargaining. There is a need for greater transparency on the role of each of the calculated inflation measures in the mix of internal targets used by the ECB. How these various internal measures relate to the estimates of achievement of success in relation to the rates of inflation perceived by the general public is not adequately measured. The public’s expectations of inflation are, therefore, not used to calibrate the success or otherwise of inflation targeting, rather the principal assessment used is that of professional forecasters. Regular, structured public surveys should be used as the main measure of success.
Other GPI concerns – arising from the potential impact of the complex set of measures that comprise the monetary policy ‘toolkit’ deployed by the ECB – were considered; notably, the danger that the Assets Purchasing Programme (APP), especially via the household portfolio transmission channel, is having a net negative impact on wealth distribution, and thus exacerbating wealth inequality across the EZ.
A major concern of the GPI is absence of genuine democratic accountability for the ECB despite the regular appearances of the President of the ECB before the European Parliament and the plethora of both technical and general information provided by the ECB through various communication channels and social media. In part, this problem is due to the complexity of monetary policy as it has developed over the past 15 years. In part, it is also due to the need for institutional and policy reform within the EU and the EZ. In both these areas GPI has suggested substantive reforms which will improve the ECB’s communications with citizens. But we firmly believe that, whatever its technical merits, a considerable benefit of NGDP targeting will provide the general public with a much better appreciation of what monetary policy is trying to achieve, either independently or, preferably, in close alignment with a federal fiscal policy.
In addition to monetary policy, there is an urgent need, as called for by the President and other Board Members of the ECB, for a substantial fiscal stimulus, across the Member States, as a necessary accompaniment to monetary action by the ECB. The evolution of the confederal EU, as we indicated in our Federal Central Banks (2018), requires the establishment of a permanent European Monetary Fund (EMF) to act as an independent fiscal budget for the Eurozone. The 310 million euro grants element of the New Generation European Union (NGEU) establishes, albeit on a temporary basis, such a Fund, financed by the issue of bonds by the EU itself. This is an important step in the right direction, but the provision needs to become permanent. We also believe that the Eurozone Finance Ministers Eurogroup should be formally subject to democratic accountability by the European Parliament, matching that of the ECB President.
There is a general reluctance of economists commenting on ECB monetary policy 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, NGDP. 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 three decades. Central banks are pressured to offer monetary policy fixes for structural reform issues. But to ask monetary policy to go beyond an appropriate narrow remit is a step too far and is the fundamental economic policy error of our times.