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The European Central Bank's strategy review has reached broad consensus about the need for a new symmetrical 2% price target, but officials are still arguing about whether to follow the Federal Reserve's inflation makeup strategy and some remain unsure how to incorporate climate goals into monetary policy, Eurosystem sources told MNI.
The current inflation target, of "below, but close to, 2% over the medium term" is widely recognised as inadequate for an environment in which monetary policy may more frequently find itself close to the lower bound of interest rates, sources said. But opinions on how to define symmetry, which implies that the central bank would respond to undershooting its target with equal vigour as it would to overshooting, span a wide range, with some calling for Fed-style average-inflation targeting and others favouring much more slimline approaches, one official told MNI.
"At one end, there is the simple fact that just targeting 2% allows for simple symmetry," one official said. "At the other end, one can argue for Fed-style AIT, even Fed-style plus, and every point in between has its supporter."
CLIMATE AND MONETARY POLICY
Another issue being discussed in the review, which is due to announce its results by September but might conclude earlier, is how better to account for the cost of housing in inflation measurements, a task made more difficult by a lack of monthly data, one source said. Eurostat, the EU's statistics agency, continues to examine this issue to find a workable solution, though issues remain.
One of the toughest challenges has been posed by the question of how to incorporate climate change into ECB policy. While one official said that differences in the area had been smaller than expected, others shared the scepticism on the topic expressed by Bundesbank chief Jens Weidmann. Pursuing green goals by modifying ECB bond purchasing criteria could raise issues of market neutrality, one official said, with another arguing that trying to relate climate to the inflation target would only cause confusion.
"That's not a reason to have average inflation targeting or make-up strategies, because again, I don't think we'll be able to explain them," the official said. "Why are you allowing this overshoot? Well, because we want to support climate change later on. How does that work?
"I think it's an area that probably deserves further research," the official added. "But my gut feeling is that if we came out with it now we'd have to spend the next hour explaining it."
FOLLOWING THE FED
Officials expressed differing views as to the extent to which the ECB should follow the lead of the Fed, which explicitly promises to allow inflation to overshoot its target to compensate for periods of undershooting. Finland's Olli Rehn has publicly called for such a strategy.
"I'm pretty skeptical about the Fed's approach to average inflation targeting, make-up strategies," one official said, adding that such an approach "begs a whole bunch of questions", and noting that the Fed, unlike the ECB, could also explain periods of above-target inflation by pointing to its mandate for supporting employment.
"There are bound to be some differences of view. On average inflation targeting, there definitely are," the official said, before stressing the areas of agreement. A target will always have "a certain degree of ambiguity", and will almost certainly refer to the medium term, he said.
Another official said the discussion on symmetry went beyond the definition of the price target.
"Do you want it on the price stability definition, or do you want to bring that symmetry notion –and possibly of overshooting—to the management of monetary policy tools?" the official said. "So through the management of a specific instrument - forward guidance or interest rates - I allow overshooting. Without the need to define ex-ante your strategy as a makeup strategy."
Whatever the ECB agrees this time, it should review its strategy more frequently, the official continued.
"It isn't reasonable to wait 18 years to review the strategy," said the official, adding that he thought there might be support for a system such as that used by the Bank of Canada, which examines its policy framework every five years.
The review is likely to be a focus during the ECB's annual retreat for Governing Council members pencilled in for June 18-22. While it is looking into the role of the ECB's tools in its policy response, it is not considering major changes to them, despite some officials suggesting that alterations might be necessary once the Pandemic Emergency Purchase Programme concludes net purchases in March. This discussion seems to have been pushed back a few months "in order to have a clearer picture of the new strategy framework," an official said.
An ECB spokesperson declined to comment on the matters in this article.