17 November 2019

Financial Times: Christine Lagarde must resist pressure on the ECB’s inflation target

[...] Her predecessor as president of the European Central Bank, Mario Draghi, resisted doing what she has promised to do: undertake a full review of the ECB’s monetary strategy. He had other priorities. There is, of course, a strong case for such a review. But beware of the traps.

What speaks in favour is that the ECB persistently failed to meet its inflation target of close to, but below 2 per cent. The inherent asymmetry of the target is one of the reasons why the central bank prematurely raised interest rates in 2008 and 2011, decisions that contributed to the eurozone crisis later.

The reason Mr Draghi avoided that review was in order not to have the discussion we are having now: whether the ECB should lower the target inflation rate to the actual rate, moving the goalposts to where the ball is. [...] 

The business model of German and French savings banks and insurance companies makes them critically dependent on positive nominal interest rates. The fight about inflation targets is in part about the future of national financial systems.

Ms Lagarde should resist this pressure and focus her strategic review on the shifting underlying dynamics. The ECB has been too optimistic in its forecasts for inflation and growth. There is a case for a rethink, but not for a return to the 1990s. And certainly not a return to discretionary policies or, worse, a situation where central bankers act as lobbyists for their domestic banking and insurance companies.

I think the most promising course is one for which Ms Lagarde is uniquely qualified: to get eurozone governments to understand the interaction between fiscal and monetary policy. Mr Draghi’s most important legacy is not the famous decision to do “whatever it takes”, but his farewell statement in which he spoke truth to power. He argued that the eurozone needs a central fiscal capacity large enough to act as a macroeconomic stabiliser. This is taboo in several European capitals, including Berlin and The Hague. I suspect that one reason the Germans are making a halfhearted attempt to compromise on deposit insurance is to get that discussion off their backs. 

The banking union will make the eurozone more resistant to banking crises, but not to the deep industrial and technology shocks it currently faces. In the end, stability will require the full toolkit of a deeply integrated fiscal union, with a finance minister and a mutualised safe asset.

I realise that Ms Lagarde cannot just make this happen. But she should continue Mr Draghi’s campaign for governance reform — and resist quick fixes to the inflation target.

Full article on Financial Times (subscription required)

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