MNI INTERVIEW: ECB To Drop "Meeting-By-Meeting" - Papadia
MNI (BRUSSELS) - The European Central Bank will eventually have to abandon its meeting-by-meeting approach to setting monetary policy, its former head of market operations Francesco Papadia told MNI.
ECB President Christine Lagarde and other senior officials at the central bank have insisted that the meeting-by-meeting approach will remain in place, but Papadia, who is also a fellow at the Bruegel think tank in Brussels, said the recent improvement in the central bank's forecasting means that it will have to go.
"The reason I see this is that she is insisting that the forecasts and projections are getting much better. Now for six times their inflation projections have been confirmed. If they are better then you should count on them more, and that means you are not meeting-by-meeting, but you take a more medium-term term horizon." (See MNI INTERVIEW: ECB Agrees On Gradual Cuts To Neutral - Centeno)
While he concedes that the large uncertainty surrounding U.S. President-elect Donald Trump's impact on trade policy argues for a cautious policy approach in the short term, he argued that the consequences should become clear soon after he assumes office in mid-January, when they can be built into the ECB's economic forecasting.
Improving its inflation forecasts should be the ECB's biggest task when it makes its assessment of its 2020 strategy review next year, said Papadia, director general for market operations at the central bank between 1998 and 2012.
"My view is that - not only for the ECB but for many central banks - mistakes in monetary policy mostly derive from inflation-forecasting mistakes."
While the solution to this problem is not clear, Papadia said central banks should devote their formidable "intellectual firepower" to resolving forecasting problems.
ZERO BOUND
Papadia also sees an asymmetry in the ECB's inflation toolbox depending on whether the central bank can use interest rates, which lose their effectiveness when inflation falls close to zero.
"The balance sheet is a blunt instrument that is less effective [than rates]. That should be another important point in the strategy review. Balance sheet use for monetary policy purposes was an emergency tool and the costs of this emergency tool are now being reconsidered. Yes, we did it and yes, we had to do it, but there were costs."
The ECB has also created a bond-buying tool designed to suppress any rise in sovereign yields which it sees as out of line with economic fundamentals, but this Transmission Protection Instrument is unlikely ever to be activated, according to Papadia.
"I find the probability that TPI will be used is low. It would require two things happening which are unlikely at the same time - first, that the country with problems is doing reasonable things, the second is that, nonetheless, there exists an inordinate spread. This happened and can happen again, but it's a rare event."