>> GROUP: Shadow ECB Council / EZB-Schattenrat  Katharina Utermöhl

Katharina Utermöhl: >> On which topics should the ECB focus in its monetary policy review?

There are three must-have topics the ECB’s upcoming strategy review should cover:

- The main focus should clearly be on the monetary policy framework. However this is not simply about setting a new inflation target. Above all the review should be understood as an opportunity for the ECB to deepen its understanding of the inflation process and, more precisely, why inflation has stayed so low for so long in spite of the ECB’s ultra-expansive monetary policy stance. The outcome of this exercise should then help guide any adjustments in the key elements underpinning the ECB’s monetary policy framework including the definition of the inflation target consistent with price stability and the time horizon to comply with it as well as the identification of an appropriate inflation gauge and the relevant tools to steer inflation in the desired direction.

- Further the ECB should reevaluate the transparency of its monetary policy decision-making process. In particular, a better representation of the diversity of views among policy makers could provide an outlet to and help contain to some extent the growing dissent in the governing council which - if left unaddressed - will undermine the ECB’s credibility.

- Lastly, in addition to the more “traditional” elements of its monetary policy framework, the ECB should also clarify its role in fighting climate change and provide details on how it will include climate change considerations in its monetary policy framework.

>> What would be the most important changes?

- In a context of subdued energy prices and structural drivers behind low inflation such as globalization and technological change, there are mounting doubts over the ability of central banks to precisely steer inflation towards a point target. Therefore the ECB should refrain from a substantial overhaul of its strategy but rather stick to cautiously tweaking its monetary policy framework with a view on introducing more flexibility. Along that logic the current inflation gauge as well as the 2% inflation target should be maintained. However in an effort to clarify the policy target and introduce more flexibility, the target should be made symmetric with a band around the goal that allows for a +/- 1ppt deviation. Moreover the time horizon to reach the target should be extended to five years. Regarding the ECB’s toolbox, the review should conclude how effective the various tools have been in steering inflation over the past few years and how much credit risk the ECB is willing to assume overall as a result of its asset purchase programs but also other tools such as OMT.

- The ECB should moreover adapt its communication strategy and release detailed minutes as well as take regular votes and publish the records. More openness about individual views of policy-makers will enhance monetary policy transparency and in turn also its effectiveness. In addition, providing a voice to dissenting members should help strengthen the unity of the governing council by signaling that it is able to accommodate differing views.

- Meanwhile on the inclusion of sustainability considerations, the ECB should opt for incorporating climate change considerations in its analytical models and forecasts. This extends to checking that banks are taking account of these risks in their risk management as part of the future European banking stress test.

>> What outcomes do I expect in reality?

- The ECB Strategy Review will hardly be a walk in the park. Arguably since the last review in 2003, if anything the issues facing central banks around the globe have multiplied and become far more complex. This is perhaps particularly true for the ECB since the eurozone economy has undergone profound changes over the last few years. A strategy review is essential and overdue but it will hardly brush aside the differences within the governing council which to a large extent are not about subtle disagreement in style but instead concern fundamental differences about what a central banks should and should not do. Moreover with President Lagarde expected to pursue a more collaborative leadership style she is unlikely to impose any strategic changes in the absence of a clear majority. As a result instead of a complete overhaul, the changes to the monetary policy framework will probably be more subtle.

- Most likely we will see a compromise solution on the inflation target that keeps it at 2% but clarifies it by making the goal symmetric. After all a higher inflation target would be inappropriate for some members on the basis that the ECB has struggled to even reach the 2% goals and that it would stretch the interpretation of “price stability”, whereas a lower target would have some members concerned that as a result interest rates could stabilize at too low a level to provide a buffer against future economic downturns. Meanwhile the current inflation gauge will be maintained – perhaps though complemented by additional measures of underlying inflation – while the timeframe to reach the inflation target as well as the currently employed policy tools will be confirmed for lack of alternatives.

- There should be broad agreement on incorporating climate change considerations in European bank stress tests as well as applying sustainability criteria to the management of public sector pensions. However a redirection of ECB asset purchases towards “green” bonds will prove to be another controversial topic and in any case would require regulators to agree on a common framework for sustainable finance first.
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