The European Central Bank on Thursday unveiled a new policy-making strategy, and give its leaders credit for courage. The ECB has been dogged from its birth with questions about and challenges to its political legitimacy. The governing council has decided to ramp up the pressure on itself even more.
The ECB’s last monetary overhaul was in 2003—one global panic, seven new eurozone members, multiple sovereign debt crises, three Greek bailouts, a Brexit and a pandemic ago. During that span the ECB has positioned itself as the primary institution capable of gluing the eurozone together, and it has dramatically expanded its role in Europe’s economy via extensive lending subsidies and purchases of government and corporate bonds while rolling out negative interest rates, which are a tax on deposits.
To what end? It’s about time someone asked that question anew, so kudos to ECB President
for doing so. Alas, her answer isn’t likely to help eurozone economies or the ECB as an institution.
As a start, the ECB is changing its inflation target, which the 2003 review had set at “close to but below 2%.” The ECB now says its 2% target is “symmetrical,” meaning it views undershoots and overshoots as equally serious.
This stops short of the Federal Reserve’s average inflation target, announced last year, under which the explicit policy is to achieve inflation above 2% periodically to make up for periods of below-target inflation. The ECB’s symmetry means Ms. Lagarde and Co. will try as hard to push inflation up to 2% as they will try to pull it back down to 2%. No more pre-emptively applying the brakes as inflation inches up toward the target.
The practical effects of this shift will be limited since the ECB for years has acted as if this is its policy. But don’t underestimate the political ramifications. A symmetrical target breaks with Germany’s tradition of viewing inflation overshoots as far more dangerous than undershoots. No one can say how German or other northern European voters might react if the ECB starts routinely tolerating price rises above 2% in the name of symmetry.
At least the ECB recognizes it has a poor understanding of what the eurozone inflation rate actually is. The review calls for incorporating a measure of owner-occupied housing prices into the index the ECB tracks. It won’t be easy. Technical problems plague such price statistics in other developed economies, and it may take years for the ECB to find a way around those challenges and difficulties unique to the eurozone. But the ECB finally will account in some limited and imprecise way for the effects of its policies on a major asset price that affects households.
The bank’s worst policy shift concerns climate change. The new strategy decrees the ECB will factor environmental concerns into monetary policy “in relation to disclosures, risk assessment, corporate sector asset purchases and the collateral framework.” The climate “action plan” released with the new strategy explains this would require climate-related disclosures from companies whose bonds are used as collateral at the central bank. The ECB could also tilt its purchases of corporate bonds under quantitative easing toward ostensibly green companies.
This is a huge mistake. The ECB faces enough challenges to political legitimacy from its purchases of government bonds, which amount to a subsidy for fiscally profligate capitals such as Rome. Now Ms. Lagarde will wade into politicized capital allocation to businesses.
ECB governors may think they have political blessing for such a move, since EU governments have embraced climate concerns as a political priority. But that enthusiasm is starting to wane in some capitals. It will wane even more if unelected monetary maestros at the ECB start penalizing national champions such as France’s Total, Shell in the Netherlands or Italy’s Eni. Even in Germany, where voters might support the green agenda, the ECB’s climate moves will embolden critics who worry about the central bank’s ever-expanding remit.
This strategy review took observers by surprise because it was released several months ahead of schedule. This suggests the ECB’s ideologically diverse governors found it easier than expected to agree on the central bank’s new direction. There’s no guarantee that other Europeans will agree as the ECB implements the strategy in years to come.
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