(Bloomberg) — Christine Lagarde is poised to make her mark as president of the European Central Bank by firing the starter gun on its biggest-ever strategy review.
On Thursday the new chief will ask colleagues to sign off on that yearlong rethink, starting a process questioning the ECB’s inflation goal that was last broached in 2003. It will also address topics for the new decade including inequality, technology and climate change.
That broad palette is bold, and some observers worry it will raise unrealistic expectations over what a central bank can achieve. Officials still haven’t properly revived inflation despite years of massive monetary stimulus, and fear more objectives will divert from their primary mandate.
For Lagarde, a former politician rather than an economist, the rethink is overdue. Radical policies such as negative interest rates and asset purchases are hugely unpopular in some countries. She wants to listen to citizens so the ECB is “not just preaching the gospel that we think we master.”
The review’s parameters aren’t yet settled, and the 25 policy makers will start their two-day meeting earlier than usual to give them more time to do so. The Governing Council dinner on Wednesday could be particularly lively.
Most officials agree they should first analyze why inflation is stubbornly low. Their goal is “below, but close to, 2% over the medium term,” yet price growth is struggling to exceed 1%.
Most developed economies face similar difficulties though. Researchers have offered explanations including globalization, technology and weaker labor standards, and it’s unclear how much the review can add.
At least the ECB can look for guidance to U.S. Federal Reserve, whose own review started in early 2019, with findings due this year.
Symmetry and Precision
For many, the goal is part of the problem. When the ECB was created in 1998 it defined price stability — its mandate from governments — as inflation “below 2%.” Officials “clarified” what that meant in the 2003 review.
The concerns are that the wording is too imprecise, and that it’s a legacy of an era when too much inflation was the only worry. The danger now is that there’s too little, ultimately risking a dangerous deflationary spiral.
Most economists expect the ECB to switch strategy and give equal weight to too-low and too-high inflation, an approach that could allow for greater policy flexibility. Known as symmetry, that’s something Lagarde’s predecessor, Mario Draghi, pushed for aggressively last year.
The goal could also be honed. Benoit Coeure, a recently retired Executive Board member, argued for a 2% target, which may have broad support. He also argued for a tolerance band that allows short overshoots or undershoots, a thornier subject. Others want a band, but with 2% at the upper end, or consider any inflation within the range as acceptable.
There will be counter-arguments. Bundesbank President Jens Weidmann is open to proposals but sees no pressing need to change the goal, while Austrian central banker Robert Holzmann has suggested reducing it.
A related question will be what inflation measure the ECB should target. The European Union’s official index significantly underweights housing, a major cost for consumers.
Policy tools will also be reviewed, though clues on that are sparse. The ECB currently relies on negative rates, quantitative easing, and long-term loans to banks. Lagarde acknowledges their side effects but has defended the instruments, albeit not always enthusiastically.
The ECB may instead change its cross-checks on price-stability risks under its so-called two-pillar strategy. One of those, money supply, has been a poor guide to inflation and could be downgraded. Instead, financial stability might be more closely linked to monetary policy, as Bank of France Governor Francois Villeroy de Galhau suggests.
An outside chance is that the ECB adopts its own digital currency, giving it greater control over money in the economy. Lagarde has talked about that and an ECB taskforce is investigating the possibility. Some governors aren’t yet convinced.
What Bloomberg’s Economists Say
“The report will probably consider the potential for new tools as well. Coeure raised the possibility of the central bank offering accounts to private individuals. We expect some assessment of digital currencies to be within the scope of the review. As Lagarde said recently, society is facing ‘massive technological change.’ Central banks are too.”
–David Powell and Maeva Cousin, See their ECB PREVIEW
While debating inflation could be all-consuming, Lagarde wants to go further, having pledged to “turn each and every stone.”
One controversial item she’ll insist on is how the ECB can fight climate change. The boldest move — favoring so-called green bonds in QE or discouraging bonds for carbon-intensive investments — is widely resisted by colleagues, who see it as a social judgment that should be left to investors or governments.
However most policy makers accept there are steps they can take. That could include working with ratings companies on a “green” rating system for bonds, or adopting sustainable investment criteria being devised by the European Commission.
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Lagarde also wants the review to consult widely, talking to academics, lawmakers and civil society groups as well as central bankers. She may pursue a series of town-hall meetings similar to the “Fed Listens” events, carrying the risk that officials don’t like what they hear.
Some officials doubt Lagarde’s timetable of finishing before the end of the year, noting how long the Fed’s review has taken. Instead, they may make decisions based on interim findings, and push work into 2021 on issues they can’t agree on.