01 December 2019

Bloomberg: What Lagarde’s ECB review can tackle, from inflation to climate

A strategic review of the institution’s mission could be announced within weeks, and Lagarde has signalled that it will almost certainly include climate change alongside the standard central-bank topics of inflation, financial stability and communication.

Yet it’s a task that needs to be done. Years of failing to hit their inflation target -- despite ever-more innovative ways of pumping trillions of euros in the financial system -- has left ECB officials worried about their credibility. The U.S. Federal Reserve plans to complete its own strategic review in mid-2020.

So while ECB Chief Economist Philip Lane has warned against trying to guess the outcome of the assessment, Lagarde’s first testimony to the European Parliament will be closely scanned for clues on her intentions. Here are some of the issues that could be on the table:

• Inflation target - a fundamental question is whether the inflation goal is set at the right level. The ECB’s primary mandate from governments is to ensure price stability -- it was the central bank itself that decided in 2003 to interpret that as inflation “below, but close to 2% over the medium term.”
• Inflation gauge - another question is whether the official inflation gauge, prepared by the European Union’s statistics office, is appropriate. Economists have argued that the measure underestimates true price growth by failing to adequately include housing costs.
• Mandate gazing - the ECB’s primary mandate of price stability is baked into EU treaty law, though that doesn’t mean it can’t be changed if governments agree. Approaches differ elsewhere -- since 1977, the Fed has been tasked with achieving both stable prices and maximum employment. If Lagarde doesn’t want to push things that far, she also has the option of putting more emphasis on the secondary mandate, to support the “general economic policies” of the EU. That could mean linking monetary tools more closely to financial stability ones, as Bank of France Governor Francois Villeroy de Galhau has suggested.
• Climate change - climate change is emerging as a key point of focus, with Lagarde saying the review would be a good moment for the ECB to reflect on the role it can play in sustainability.
• Communication dilemmas - a broader debate on how to better engage with the public is likely to be on the table, but discussions could also center on whether the Governing Council should emulate its major peers by making voting on decisions a standard procedure, with the votes of each policy maker published. It currently strives for agreement by consensus, and the policy account doesn’t put names to viewpoints.
• Instrument appraisal - Draghi took the ECB into unprecedented territory with broad-based asset purchases, negative interest rates, and long-term bank loans. All of that could now come under scrutiny as policy makers judge side effects that the ECB’s own Financial Stability Review says are becoming ever more pronounced.

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