ECB strategy review – don't waste the chance

At first glance, the upcoming revision of the ECB's monetary policy strategy next year is merely a matter for experts. But far from it! It is about the important question of how the ECB intends to prevent another inflation shock in the future. I suggest four changes to the monetary policy strategy.

Inflation: from point target to target range

Firstly, the ECB should revise its definition of price stability. So far, it considers its target reached when its medium-term inflation forecast is two percent. But no central bank in the world can control inflation with such an accuracy. They regularly fail on this overly ambitious target, which negatively affects their credibility.

A target range of plus/minus 0.5 percentage points around two percent would be superior to a point target. This would not only enhance the ECB's credibility, but would also make its monetary policy more stable. If the forecast inflation rate deviates only slightly from two percent, it would not be forced to take bold countermeasures. As in September 2021, it must not justify the use of instruments such as negative interest rates or broad-based bond purchases only because it forecasts an inflation rate of 1.9% rather than 2.0% in the medium term. In view of the high forecasting uncertainty, this is abstruse.

Symmetrical instead of asymmetrical use of instruments

Secondly, the ECB should no longer implement its monetary policy instruments asymmetrically. Until now, the ECB has reacted more strongly to an inflation rate below two percent than to one above. It justifies this asymmetry in the use of tools by arguing that if inflation is too low, the economy could slide into harmful deflation with falling consumer prices, from which the ECB would hardly be able to rescue it.

However, such deflationary traps can hardly be observed in economic history. For example, the Bank for International Settlements (BIS) has shown that phases of falling consumer prices during the gold standard (until the outbreak of the First World War) and since the end of the Second World War have been accompanied by rising and not falling GDP. The frequently cited Great Depression in the USA in the 1930s is not a good counterexample because the falling prices were not the cause of the economic crisis, but the result of a shortage of money triggered by the collapse of around a third of US banks.

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