MNI POLICY:ECB's Lagarde Opens Door To Inflation Target Revamp

The European Central Bank's price stability target should change to reflect current concerns, Christine Lagarde said Wednesday, in a wide-ranging speech in which she expressed support for average inflation targeting, improving inflation measures and the formal 'normalisation' of unconventional monetary policy tools.

The current environment of lower inflation means today's concerns are different to those of 2003, when the ECB adopted an inflation aim of "below, but close to, 2%", Lagarde said. Ensuring that there is "sufficient space above zero to re-empower conventional monetary policy" is becoming more important, at the same time as there is a need to ensure that the ECB's aim is perceived to be symmetric by the public, she added.

The ECB should also consider revising its understanding of the "medium term" horizon over which price stability is oriented, she said, since a persistent failure to meet the inflation aim feeds into inflation expectations and calls for a shorter horizon.

"The wider discussion today," she continued, "is whether central banks should commit to explicitly make up for inflation misses when they have spent quite some time below their inflation goals.

"If credible, such a strategy can strengthen the capacity of monetary policy to stabilise the economy when faced with the lower bound [...] While make-up strategies may be less successful when people are not perfectly rational in their decisions – which is probably a good approximation of the reality we face – the usefulness of such an approach could be examined."

The monetary pillar of the ECB's approach to economic and monetary assessment should be "enhanced to provide information on financial stability which – over longer time horizons – could be relevant for the inflation outlook," she added.

The Harmonised Index of Consumer Prices (HICP), which has served the ECB well "so far," should be made to better reflect everyday costs and perceptions, she continued, including owner-occupied housing. "This is not about moving the goalposts for monetary policy," Lagarde said. "It is about future-proofing how we measure inflation."

The ECB president also took aim at the assumption, adopted in 2008, "that policy "normalisation" will mean returning mainly to interest rate policy and winding down unconventional policies."

"But if "normal" is closer to what we saw before the outbreak of the pandemic and, I am afraid, what we are seeing even more vividly now, we need to be prepared," she said. "We need to have a clear consensus – agreed within the Governing Council and understood by the public – on what tools are available to us when inflation is too low, and how they should be systematically deployed in response to different types of shock."

Since the restart of the monetary policy strategy review process the ECB has introduced a new work stream on monetary-fiscal interactions, she said.