The ECB President does not want to deviate from her current course.
(Photo: dpa)
The European Central Bank (ECB) is challenged like rarely to promote its policies. In view of the rapidly rising inflation rates, it must convincingly explain why it wants to hold on to negative key interest rates and massive bond purchases.
In her last press conference, she only succeeded to a limited extent. While concerns about inflation too high prevail everywhere, President Christine Lagarde said that the inflation rate expected for 2024 is still too low at 1.8 percent because it is below the ECB’s target of two percent. That makes an expansionary monetary policy necessary.
The ECB is thus walking on thin ice. In view of the high degree of uncertainty in such forecasts, is it possible to justify negative interest rates and extensive bond purchases, which are inevitably associated with real and financial side effects, with a target deviation of 0.2 percentage points?
In order to get to the safe shore, the ECB needs a different narrative. It’s easy to find if you put the assumptions of the ECB forecast in the foreground. The inflation forecast is based on interest rate assumptions that are derived from the expectations of market participants. Specifically, it is assumed that short-term interest rates will remain negative until 2023 and that long-term interest rates will hardly rise either.
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The ECB should therefore not justify its expansionary policy with the fact that inflation is likely to be a tad too low in 2024. Rather, it should justify it by stating that if interest rates were significantly higher, the inflation target of two percent would be significantly undercut in the medium term.
Peter Bofinger is Professor of Economics at the University of Würzburg and was a member of the Expert Council.
(Photo: SVR)
This would also make it clear that even if the medium-term forecast were to increase to two percent, no deviation from the interest rate path expected by market participants would be necessary. Lagarde’s current narrative suggests this fallacy.
And when do interest rates have to be increased? Exactly when, given the interest rate path, an inflation rate of over two percent is forecast for 2024.
The ECB’s unfortunate communication shows that in its strategy review in July 2021 it failed to delve into the prerequisites and implications of its “inflation targeting” strategy, for which interest rate forecasts are of central importance.
Given the great fear of inflation among the population, the ECB should no longer create the irritating impression that an expansionary policy is necessary because inflation is expected to be too low. If properly understood and applied, it can use the concept of “inflation targeting” to demonstrate that it can keep inflation under control in the medium term, despite inevitable short-term deviations.
Anyone who sees it differently should submit their forecast for 2024.
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