Should the ECB Reformulate its Inflation Objective?

Question 1: Which of the following best reflects your opinion on the following statement? “The ECB should explicitly state that it will allow inflation to temporarily exceed the 2% target following extended periods of low inflation.”

Question 2: Would you support increasing the ECB’s inflation target to a higher rate of inflation than the current 2% target?

Question 3: Which of the following best reflects your opinion on the following statement? “The ECB should explicitly recognize unemployment and/or economic growth as a secondary aim, secondary to its price stability mandate.”

Summary

The European Central Bank (ECB) is in the process of reviewing its monetary policy strategy. A majority of CfM-CEPR panel members support allowing inflation to exceed 2% following periods when inflation has been below target and making more explicit its secondary objective of supporting economic growth and full employment. Only a minority supports increasing the inflation target itself.

Background

The October 2020 CfM-CEPR survey asked members of its European panel to evaluate a variety of proposals for changes in the ECB’s strategy that have been in the policy discussion.

The European Central Bank’s Monetary Policy Strategy Review                                                        

The ECB is in the process of reviewing its monetary policy strategy. The review was due to for the end of 2020, but was postponed to mid-2021 because of the Covid-19 pandemic. The review will consider whether the ECB’s inflation aim should be reformulated and over which time horizon prices should be stabilized, among other questions.

Across the Atlantic, the Federal Reserve concluded its own strategic review in August.  One of the policy changes arising from the review was a commitment by the Fed to allow inflation to overshoot if inflation was persistently below its long-term target of 2 percent. As Fed Chairman Jay Powell stated in the Fed’s September 16 statement: “With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”

The Fed’s review also acknowledged that the Board may have overestimated the inflationary implications of the historically low unemployment rate at the end of the previous decade. Given the Fed’s dual mandate, this has been viewed by some as a de facto shift to a larger weight on unemployment in the Federal Reserve’s future policy decisions.

In contrast, the ECB’s mandate calls for price stability as its primary goal, with no specific labor market objective. In its previous review of 2003, the ECB interpreted its price stability goal as aiming for inflation “below, but close to, 2% over the medium term”. European inflation has met this target, averaging 1.7% since the euro was introduced. However, this average conflates the period before 2008, where inflation averaged around 2%, and the past decade, where inflation has averaged 1.3% and was in negative territory on several occasions.

In a recent speech discussing the pending strategic review, ECB President Christine Lagarde expressed support for moving to a more symmetrical target, with possible overshooting of the inflation target to compensate for past low inflation. As she puts it: “to underpin inflation expectations, we need to ensure that our aim is perceived to be symmetric by the public.” In support of this view, she argues that this policy “helps ensure that monetary policy is not forced too often towards the effective lower bound – the level of interest rates at which further cuts do not have the desired positive impact – when faced with shocks that push inflation too low.” This view is backed by Evans et al (2015) who argue that the asymmetry caused by the zero lower bound requires some policy accommodation following episodes of low interest rates (see also the arguments for symmetrical targets in Demertzis and Viegi, 2008 and 2010).

Banque de France President François Villeroy de Galhau has gone further and has argued that the existing framework already calls for a symmetric inflation target. In contrast, Deutsche Bundesbank President Jens Weidmann has rejected the notion that the existing target is symmetrical.

The panel was asked to express opinions on needed revisions to the ECB’s monetary policy framework.

Question 1: Which of the following best reflects your opinion on the following statement? “The ECB should explicitly state that it will allow inflation to temporarily exceed the 2% target following extended periods of low inflation.”

Thirty-six panelists responded to this question. The vast majority of panelists (75%) believe that the inflation target should be allowed to exceed its 2% target. This share increases further when weighting responses by panelists’ self-assessed confidence levels.

Panelists put forth a number of arguments in favor of allowing inflation to exceed its target following periods of below-target inflation. First, low real interest rates inevitably mean that the ECB will be hitting zero nominal interest rates more frequently. As Pietro Reichlin ( Università LUISS Guido Carli) put it: “ There is large consensus that structural problems (demographics, pace of innovation, excess savings) are behind a long term fall of real interest rates, so that the range of inflation rates compatible with the zero lower bound is shrinking.”  Second, in the current context, this policy would add credibility to monetary policy announcements calling for a prolonged period of low interest rates. Francesca Monti (Kings College London) writes that “the makeup strategy… would make the current low-for-longer policies more credible… and therefore more effective.” Third, this policy could avoid the scarring effects of recessions. Wendy Carlin (University College London) posits that “allowing inflation to rise above target is part of a strategy that (implicitly) targets the pre-recession output level, avoiding a permanent loss of output arising from scarring.”.

Opponents of this proposal pointed its lack of clarity, credibility, and implementability. Regarding clarity and credibility, Robert Kollmann  (Université Libre de Bruxelles) asserts that “to keep her credibility, the ECB needs clear and verifiable objectives. The freedom to [allow] ‘inflation to temporarily exceed the 2% target following extended periods of low inflation’ seems too vague: What is the meaning of ‘temporary’? By how much would inflation be allowed to overshoot?” On implementability, Martin Ellison (University of Oxford) expresses his doubts: “Average inflation has been well below 2% over the last decade, despite the best attempts of the ECB to follow unconventional policies. From that base, it’s difficult to believe that a promise to support higher inflation after a period of low inflation will have much bite.”  Michael McMahon (University of Oxford) further points out that nothing prevents the ECB from doing so under its current stated objective: “[the ECB] is already able to do this and has had periods of its history when inflation was above target. The bigger issue is that the target is not 2% but rather the target it close to but below, with plenty of ambiguity about exactly what that is. So 1.8% is likely above its target, or, more precisely, above the definition of price stability to fulfil its price stability objective.” Kate Barker (Universities Superannuation Scheme) adds that “this change seems to me to fail two tests. It might prove hard to achieve (failing credibility) and in the long run poses the challenge of what to do following high inflation as a result of a fall in the exchange rate”.

Martin Ellison, Michael Wickens (Cardiff Business School & University of York) and Simon Wren-Lewis (University of Oxford) compared this policy proposal to price level targeting, but differed on whether this was desirable or not. Martin Ellison refers to this policy as a “poor man’s price level target”.

A higher inflation target?

A related question is whether a 2% inflation target is appropriate when the (real) natural rate of interest is low and potentially negative. Revising the inflation target doesn’t appear to be part of the ECB’s strategic review and the Federal Reserve Chairman has rejected this possibility in the US. Nevertheless, several academic economists have suggested that a higher inflation target (e.g. 4%) is more appropriate in light of low equilibrium real rates (see for example Blanchard et al 2010 and Andrade et al 2019). In this regard, the second question asks:

Question 2: Would you support increasing the ECB’s inflation target to a higher rate of inflation than the current 2% target?

Thirty-six panel members responded to this question. A slight majority (50% or 56% when weighting by confidence levels) opposed increasing the inflation target, but a substantial minority (33%) supported a higher target.

The minority supporting a higher inflation target argue that low real interest rates require higher inflation to avoid negative nominal interest rates. John Hassler (Institute for International Economic Studies, Stockholm University) comments that “an inflation target as low as 2 percent therefore implies that actual central bank policy rates often will have to be negative and occasionally at their lower bands. A higher inflation target would ease these problems.” Wendy Carlin asserts that “the arguments for raising the inflation target are quite compelling given the forces keeping the long run equilibrium real rate of interest low. But it would need to be a coordinated move by central banks to a higher target to avoid, for example, (if the ECB were to do this alone) the trend nominal depreciation of the euro (in equilibrium), which might be difficult for a wider public to understand.”

Supporters also argue that drastic moves are required to raise inflation expectations. Martin Ellison, together with Kevin O’Rourke and Sang Seok Lee, put forth the following argument in their research on “The Ends of 30 Big Depressions”: “Abandoning the gold standard was instrumental in ending the Great Depression in many countries. The turnaround in inflation expectations (and subsequent economic recovery) only started when many countries left the gold standard. Something equally dramatic may be needed to get inflation expectations up. Changing the inflation target could be a big enough policy change to make it work.”. Francesca Monti summarizes that “while the costs of inflation are still very debated (e.g. see Nakamura et. al QJE 2018), the advantages of a higher inflation target in a world of lower interest rates are more clear, specifically the ability to operate with conventional policy tools when faced with a downturn.”

However, the majority view was that this move isn’t credible and would only be successful if inflation expectations become far less anchored. Michael McMahon mentioned he is “[worried] that announcing an increase when inflation is currently persistently low will not be credible and the move will simply increase the extent of the inflation shortfall”. Ricardo Reis (London School of Economics) adds that “the benefits seem to be outweighed by the large costs of communicating this change to a public for whom, at the individual level, this has negligible welfare impact”. Jagjit Chadha (National Institute of Economic and Social Research) opines that this move “will unhinge inflationary pressures without any great gain”.

A Dual Mandate

In the same conference, Weidmann expressed a different view: “It is worth highlighting that we do not have a dual mandate like the Federal Reserve. That is one reason why the decisions the Fed takes with regard to its monetary policy strategy cannot simply be transferred to the euro area.”

The ECB’s official objective (outlined here) notes that “[to] maintain price stability is the primary objective of the Eurosystem”. It also states that "Without prejudice to the objective of price stability”, the Eurosystem shall also “support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union”. These include inter alia "full employment" and "balanced economic growth".

Question 3: Which of the following best reflects your opinion on the following statement? “The ECB should explicitly recognize unemployment and/or economic growth as a secondary aim, secondary to its price stability mandate.”

Thirty-four panel members responded to this question. The majority of panelists (65%, or 69% when weighted for degree of confidence) agreed for a clearer objective with respect to the real economy (compared with 21% that disagreed).

Supporters of a dual mandate point to the potency of monetary policy as a countercyclical stabilization tool. Benjamin Moll (London School of Economics) points out that “monetary policy is a flexible policy tool with a potentially powerful effect on real outcomes like unemployment, GDP etc, so why not partially use it to this end?” Simon Wren-Lewis goes further and suggests making “economic growth the primary target, subject to achieving an inflation target within some time horizon”. Pietro Reichlin suggests that monetary policy needs to step in due to “limited fiscal space of some countries”. As articulated in Section 2.1 of his paper in the Vitor Constancio Festschrift, titled “The Future of Monetary Policy and Macroprudential Policy”, Lars Svensson (Stockholm School of Economics) makes a case for “price stability:” I would prefer to formulate the objective of ECB’s monetary policy as ‘price stability and full employment without prejudice to the price-stability objective,’ where ‘without prejudice...’ is clarified to mean that average inflation over a period such as 4-5 years shall be close to a symmetric inflation target of 2%.”

Opponents of a dual mandate (and even a few proponents) question whether this is feasible in light of diverging economic conditions across the Eurozone. Wendy Carlin notes that “with some countries booming and others stagnating, it is not clear how a true dual mandate could work in the eurozone”. Wouter Den Haan (London School of Economics) adds that “with a very heterogeneous currency zone, this would be very difficult and put quite a bit of pressure on the ECB”. Further, a number of panelists suggest that the ECB has sufficient flexibility in its current policy framework to address unemployment as a secondary objective. Michael McMahon notes that “the current mandate in the Treaty is sufficient to allow concern for issues of economic growth and unemployment to be important in the decision-making of the ECB”.

References

Andrade, Philippe, Jordi Galí, Hervé Le Bihan, and Julien Matheron “The optimal inflation target and the natural rate of interest”, Brookings Papers on Economic Activity, Fall 2019.

Blanchard, Olivier, “Rethinking Macro Policy,” VoxEU.org, 16 February.

Demertzis, Maria and Nicola Viegi, “Inflation Targets as Focal Points”, International Journal of Central Banking, Vol. 4 No. 1, March, 55-87, 2008

Demertzis, Maria and Nicola Viegi “Inflation Targeting: a Framework for Communication”, B.E. Journal of Macroeconomics (Topics), Vol. 9, 1, 2010.

Ellison, Martin, Sang Seok Lee and Kevin Hjortshøj O'Rourke, “The Ends of 30 Big Depressions”, NBER Working Papers, July 2020.

Evans, Charles, Jonas Fisher, Spencer Krane, and François Gourio “Risk management for monetary policy near the zero lower bound,” Brookings Papers on Economic Activity, Spring 2015.

Emi Nakamura, Jón Steinsson, Patrick Sun, and Daniel Villar “The Elusive Costs of Inflation: Price Dispersion during the U.S. Great Inflation” Quarterly Journal of Economics, 133(4), 1933-1980, November 2018.

Svensson, Lars, “The Future of Monetary Policy and Macroprudential Policy,”  The Future of Central Banking, Festschrift in honour of Vitor Constancio, European Central Bank, pp. 69-123, December 2018.  

 

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How the experts responded

Question 1

Participant Answer Confidence level Comment
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Strongly agree Extremely confident
A maximum rate of inflation was never a coherent target. The central bank was unable to guarantee that it would meet such a target and such a target isn't desirable. An upper bound perhaps made sense for a young central bank attempting to gain credibility, but certainly not a central bank entering its third decade and finding it hard to increase inflation expectations.
Jumana Saleheen's picture Jumana Saleheen CRU Group Disagree Very confident
The only good argument for the ECB to follow the Fed, in announcing an average inflation targeting framework, is to harmonise policy frameworks on both sides of the Atlantic. Such harmonisation makes it easier for financial markets to make calls on the euro/$ - a benchmark currency for global trade. I am critical of the success of such an average inflation targeting framework for many reasons. (1) It is not tried and tested (2) It is less transparent - if like the Fed the ECB are not explicit about the period over which they seek the average inflation target to be met. (3) (2) means it would be harder to evaluate the success of the ECB in meeting its remit, and thereby it would weaken the accountability of the ECB Governing Body.
Jagjit Chadha's picture Jagjit Chadha National Institute of Economic and Social Research Neither agree nor disagree Confident
A symmetrical target is a much better next step. And then a move to one pursued flexibly in the manner suggested.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Agree Very confident
It is almost always useful if monetary policy is very transparent. This is definitely true for this topic.
Michael McMahon's picture Michael McMahon University of Oxford Neither agree nor disagree Confident
The issue is not that the ECB doesn't allow inflation above target; in a sense it is already able to do this and has had periods of its history when inflation was above target. The bigger issue is that the target is not 2% but rather the target it close to but below, with plenty of ambiguity about exactly what that is. So 1.8 is likely above its target, or, more precisely, above the definition of price stability to fulfil its price stability objective.
Mirko Wiederholt's picture Mirko Wiederholt Science Po Agree Confident
Martin Ellison's picture Martin Ellison University of Oxford Agree Not confident
The idea of letting inflation drift above 2% for a while after periods of low inflation is a poor man’s price level target. I’ve no objection to the ECB doing this, but I am doubtful that it will deliver very much. Average inflation has been well below 2% over the last decade, despite the best attempts of the ECB to follow unconventional policies. From that base it’s difficult to believe that a promise to support higher inflation after a period of low inflation will have much bite. There are so many things that can go wrong. What if the promise is not believed? What if people (possibly rationally) think that monetary policy is now so weak that the ECB can never get back to 2% inflation? Do we really trust policymakers not to turn hawkish as soon as inflation rises to 2%? There is a danger that price level targeting is a distraction that is “too clever by half”, a policy drawn up in academic models without sufficient regard for the real world. I get the math of how it is supposed to work in theory, but in practice its effects are likely to be diluted by general scepticism and a lack of credibility. More potent policies are needed.
David Cobham's picture David Cobham Heriot Watt University Strongly agree Very confident
But note that there remains an instrument problem: if you say you want inflation higher that may not achieve much on its own unless you have suitable instruments to get you there, and it's really not clear that central banks have such instruments in the current circumstances.
Wendy Carlin's picture Wendy Carlin University College London Strongly agree Confident
This is important as part of the restoration of the role of monetary policy in stabilization, and for a second scenario. If inflation expectations are partially anchored on the inflation target and there is hysteresis, then following a negative demand shock, allowing inflation to rise above target is part of a strategy that (implicitly) targets the pre-recession output level, avoiding a permanent loss of output arising from scarring.
Francesca Monti's picture Francesca Monti Kings College London Agree Very confident
There is evidence that the natural rate of interest has fallen in the last decade, implying that the likelihood of reaching the effective lower bound, where the available policy tools are less effective, is higher. Also, inflation seems to have been less responsive to slack in recent years, impinging on the policymakers ability to control inflation. The makeup strategy implied by the statement in Question 1 would help policymakers in the current context, because it would make the current low-for-longer policies more credible (because implicit in the strategy), and therefore more effective. It would also help to ensure that inflation expectations are more closely aligned to the target.
Lars E O Svensson's picture Lars E O Svensson Stockholm School of Economics Strongly agree Extremely confident
The ECB should have a symmetric inflation target of 2% and, in particular, keep average inflation over a few years (for example, 4-5 years) close to the target.
Pietro Reichlin's picture Pietro Reichlin Università LUISS G. Carli Strongly agree Very confident
There is large consensus that structural problems (demographics, pace of innovation, excess savings) are behind a long term fall of real interest rates, so that the range of inflation rates compatible with the zero lower bound is shrinking. On top of that, higher inflation may be a good way to make the surge in government debts more sustainable.
Gino A. Gancia's picture Gino A. Gancia Queen Mary University of London Disagree Not confident
John Hassler's picture John Hassler Institute for International Economic Studies (IIES), Stockholm University Strongly agree Very confident
Allowing a temporary overshoot and communicating it in advance has two important benefits. First, real interest rate decrease in recessions. Second, the long run price level becomes more predictable.
Antonio Fatás's picture Antonio Fatás INSEAD, Singapore Strongly agree Very confident
Chryssi Giannitsarou's picture Chryssi Giannitsarou University of Cambridge, Faculty of Economics Agree Confident
Fabrizio Coricelli's picture Fabrizio Coricelli Paris School of Economics Disagree Very confident
Not clear why past inflation should be relevant for setting current policy, which should be related to current and expected inflation. If below target past inflation is a signal of ineffective monetary policy and thus uncertainty on effects of policy also in the future, abandoning an explicit target may be desirable.
Ricardo Reis's picture Ricardo Reis London School of Economics Agree Very confident
In Sintra in 2019, President Draghi stated: "our policy aim was fully symmetric, and it was symmetric around the level that we had established in 2003: below, but close to, 2%. It is achieving this aim over the medium term that steers our policy decisions.” The ECB does not need to change this, but simply explain that medium-term means: on average over the next 4-6 years. And perhaps remove the "below".
Kevin Hjortshøj O'Rourke's picture Kevin Hjortshøj... Oxford University Agree Confident
Kate Barker's picture Kate Barker British Coal Staff Superannuation Scheme Strongly disagree Very confident
This change seems to me to fail two tests. it might prove hard to achieve (failing credibility) and in the long run poses the challenge of what to do following high inflation as a result of a fall in the excnage rate,
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York Agree Confident
The weakness of this proposal is that it is too vague. How high should inflation be allowed to rise above 2% and for how long? This proposal is a variant on the notion of price level targeting. If prices are below the target path then they are allowed to rise faster until they reach the path. The advantage of price level targeting over this proposal is that it removes the vagueness. The fundamental problem for the ECB remains for both types of rule: even if the average euro area is 2%, in the past inflation in individual countries has been very different resulting in permanent losses of competitiveness. I propose instead a price level target path for each country.
Philippe Bacchetta's picture Philippe Bacchetta Université de Lausanne Strongly agree Extremely confident
Sir Charles Bean's picture Sir Charles Bean London School of Economics Agree Confident
Simon Wren-Lewis's picture Simon Wren-Lewis University of Oxford Strongly agree Extremely confident
As many have argued, price targeting in a recession makes sense because lower future interest rates provides some stimulus in the recession
Cédric Tille's picture Cédric Tille The Graduate Institute, Geneva Strongly agree Extremely confident
Evi Pappa's picture Evi Pappa European University institute Agree Extremely confident
Some kind of flexible Inflation targeting with elements of discretion in exceptional times to me seems the most prudent and clear objective for the ECB.
Linda Yueh's picture Linda Yueh London Business School Agree Confident
Costas Milas's picture Costas Milas University of Liverpool Disagree Confident
Benjamin Moll's picture Benjamin Moll London School of Economics Agree Not confident
Harris Dellas's picture Harris Dellas University of Bern Strongly disagree Very confident
I see risks (more discretion) and no benefits. Is there any serious research indicating that such asymmetry has compromised anything good?
Jean Imbs's picture Jean Imbs Paris School of Economics Strongly agree Extremely confident
Lucio Sarno's picture Lucio Sarno Cass Business School Agree Confident
Gernot Müller's picture Gernot Müller Eberhard-Karls-Universität Tübingen Agree Very confident
Robert Kollmann's picture Robert Kollmann Université Libre de Bruxelles Disagree Confident
To keep her credibility, the ECB needs clear and verifiable objectives. The freedom to “allow inflation to temporarily exceed the 2% target following extended periods of low inflation” seems too vague: What is the meaning of "temporary"? By how much would inflation be allowed to overshoot?
Panicos Demetriades's picture Panicos Demetriades University of Leicester Strongly agree Extremely confident
I agree with the arguments out forward by Madame Lagarde. In addition, the fiscal response to the pandemic can only be maintained for as long as necessary in the knowledge that there is sufficient monetary accommodation, albeit indirectly through PEPP. It’s paramount to avoid raising taxes or tightening monetary policy before the economy recovers fully.
Ugo Panizza's picture Ugo Panizza The Graduate Institute, Geneva (HEID) Agree Very confident

Question 2

Participant Answer Confidence level Comment
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Neither support nor oppose Not confident
Jumana Saleheen's picture Jumana Saleheen CRU Group Support Extremely confident
The ECB has persistently undershot its inflation target of "below but close to 2%": Euro Area inflation averaged ~1.4% since 2010, and 1.2% since 1999. There are many explanations for this performance and may solutions have been suggested - including raising the inflation target. There are pros and cons to raising the inflation target (e.g. see Gagnon and Collins, December 2019). The cons include costs of higher inflation (if we get there) and confusion if the EU has a different target to other major economies. The pros are that it grants the central bank more policy space, which it can then draw on to stabilise business cycle fluctuations in output. On balance I think the benefits outweigh the costs.
Jagjit Chadha's picture Jagjit Chadha National Institute of Economic and Social Research Oppose Confident
It will threaten price stability or notions of what constitutes price stability to have an inflation target much above 2%. There might be a case of a small increase to 2.5%, as was the original centre of the target in the UK and that may allows some more national diversity in response to shocks. But most people tend to argue for a much large increase which will unhinge inflationary pressures without any great gain.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Strongly oppose Very confident
This would not be credible at all in the current environment.
Michael McMahon's picture Michael McMahon University of Oxford Neither support nor oppose Confident
Here I am more nervous. It is clear that raising the inflation target, if credible, could build capacity in nominal interest rates and reduce the frequency of a binding lower bound on nominal interest rates. But I worry that announcing an increase when inflation is currently persistently low will not be credible and the move will simply increase the extent of the inflation shortfall. The ECB, or other central bank, would ideally be able to first show that they can get inflation up to a higher level, and then show that they can get it back to the existing target, before announcing the new target. Failing this, moving to a 2% symmetric target would be an improvement for the ECB in my view. As discussed above, the current objective is close to but below 2%.
Mirko Wiederholt's picture Mirko Wiederholt Science Po Neither support nor oppose Confident
I think this is an interesting idea, but I am not sure it is the right moment to increase the inflation target to a higher value when the ECB even has difficulties meeting the 2% target.
Martin Ellison's picture Martin Ellison University of Oxford Strongly support Confident
It’s unclear whether raising the inflation target is a silver bullet. Compared with the “allow inflation to exceed 2% for a period after low inflation” proposal in the previous question, it does though have the benefit of being a bold move. In my own research on the Ends of 30 Big Depressions (with Kevin O’Rourke and Sang Seok Lee, https://www.nber.org/papers/w27586), we argue that abandoning the gold standard was instrumental in ending the Great Depression in many countries. The turnaround in inflation expectations (and subsequent economic recovery) only started when many countries left the gold standard. Something equally dramatic may be needed to get inflation expectations up. Changing the inflation target could be a big enough policy change to make it work.
David Cobham's picture David Cobham Heriot Watt University Oppose Confident
This might have been useful in the immediate aftermath of the financial crisis, but its time has now passed. The instrument problem is relevant here too.
Wendy Carlin's picture Wendy Carlin University College London Neither support nor oppose Confident
The arguments for raising the inflation target are quite compelling given the forces keeping the long run equilibrium real rate of interest low. But it would need to be a coordinated move by central banks to a higher target to avoid e.g. if the EBC were to do this alone, the trend nominal depreciation of the euro (in equilibrium), which might be difficult for a wider public to understand.
Francesca Monti's picture Francesca Monti Kings College London Support Confident
The question is whether the benefits brought about by a higher inflation target are bigger than the costs of having higher inflation in normal times. But while the costs of inflation are still very debated (e.g. see Nakamura et. al QJE 2018), the advantages of a higher inflation target in a world of lower interest rates are more clear, specifically the ability to operate with conventional policy tools when faced with a downturn. What is more difficult to assess is whether such a change in strategy could be credibly implemented and would be well understood by the actors in the economy.
Lars E O Svensson's picture Lars E O Svensson Stockholm School of Economics Oppose Confident
First move to an average inflation target of 2%, to see how this works.
Pietro Reichlin's picture Pietro Reichlin Università LUISS G. Carli Support Very confident
See my answer to the previous question
Gino A. Gancia's picture Gino A. Gancia Queen Mary University of London Oppose Not confident
John Hassler's picture John Hassler Institute for International Economic Studies (IIES), Stockholm University Support Confident
The neutral real interest rate has fallen continuously over several decades and is expected to stay low for a long time. It is now substantially lower than when inflation targets were introduced. The neutral nominal interest rate is the neutral real rate plus the inflation target. An inflation target as low as 2 percent therefore implies that actual central bank policy rates often will have to be negative and occasionally at their lower bands. A higher inflation target would ease these problems.
Antonio Fatás's picture Antonio Fatás INSEAD, Singapore Support Confident
Chryssi Giannitsarou's picture Chryssi Giannitsarou University of Cambridge, Faculty of Economics Oppose Confident
Fabrizio Coricelli's picture Fabrizio Coricelli Paris School of Economics Neither support nor oppose Very confident
The key issue in the current and future environment is the whole framework for monetary policy, which should be permanently based on two instruments, policy rates and supply of safe/liquid assets. The issue of the level of the inflation target is unlikely to be crucial.
Ricardo Reis's picture Ricardo Reis London School of Economics Oppose Very confident
Structural changes suggest an increase in the optimal target of, at most, maybe 0.5-1%. The benefits seem to be outweighed by the large costs of communicating this change to a public for whom, at the individual level, this has negligible welfare impact. Moreover, it seems reckless to risk a regime change that breaks the virtuous inattention cycle we have been in for more than a decade (people expect 0-2%, we get 0-2% regardless of shocks and policy constraints).
Kevin Hjortshøj O'Rourke's picture Kevin Hjortshøj... Oxford University Support Not confident
Low equilibrium real rates won't last for ever though they could last for a good while. Policy has to be able to adjust according to the circumstances. Having said that I would prefer government investment programmes that we need for other reasons anyway and that might as a bonus raise the equilibrium real rate.
Kate Barker's picture Kate Barker British Coal Staff Superannuation Scheme Support Confident
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York Oppose Confident
If the natural rate is zero - which I think is artificially caused by current monetary policy - raising inflation to 4% would create a real interest rate of -4%. This makes little sense, especially as a long-run policy. There is no good case for this in the long run even if inflation is allowed to increase above 2% in the short run. The issue of the long-run rate of inflation is related to what other countries do. If most countries target 2%, then the euro would depreciate steadily through time. Perhaps the ECB should recall Otmar Issing's preference for a money supply second pillar in order to stimulate the economy, raise inflation and hence nominal and real interest rates. Unfortunately, there is not much scope for this while Covid-19 is rampant and suppressing economic activity.
Philippe Bacchetta's picture Philippe Bacchetta Université de Lausanne Support Confident
Sir Charles Bean's picture Sir Charles Bean London School of Economics Oppose Confident
Simon Wren-Lewis's picture Simon Wren-Lewis University of Oxford Support Confident
This is a conditional endorsement. I would withdraw this endorsement if either the central bank started using helicopter money, or if the Eurozone fiscal regime allowed fiscal stimulus during recessions.
Cédric Tille's picture Cédric Tille The Graduate Institute, Geneva Support Very confident
Evi Pappa's picture Evi Pappa European University institute Strongly oppose Extremely confident
Any substantial change in the monetary policy strategy from the part of the ECB has the danger of increasing policy uncertainty which coupled with the macroeconomic uncertainty might lead to disastrous outcomes and the loss of anchoring. Many DSGE models (See, for example, Ascari and Sbordone, JEL 2014) suggest that lifting the inflation target might result into indeterminate equilibria, which in plain words means further instability, especially of inflation. Moreover, a higher inflation target, according to same models, will lead to higher markups which will imply more distortions in the steady state and a lower level of output in the long run.
Benjamin Moll's picture Benjamin Moll London School of Economics Neither support nor oppose Not confident at all
Linda Yueh's picture Linda Yueh London Business School Oppose Confident
Costas Milas's picture Costas Milas University of Liverpool Oppose Confident
In my view, a more appropriate way of dealing with this would be for the target to be a weighted average of the 2% numerical target and the recent history of inflation with (perhaps) equal weights.
Harris Dellas's picture Harris Dellas University of Bern Strongly oppose Extremely confident
Back to the 70s!
Jean Imbs's picture Jean Imbs Paris School of Economics Oppose Very confident
Lucio Sarno's picture Lucio Sarno Cass Business School Oppose Confident
Gernot Müller's picture Gernot Müller Eberhard-Karls-Universität Tübingen Oppose Confident
Robert Kollmann's picture Robert Kollmann Université Libre de Bruxelles Oppose Confident
This is not the time to open that Pandora's box. All efforts by European policy makers should focus on overcoming the Covid crisis and boosting long-term growth (through structural and fiscal reforms), which would increase real equilibrium rates.
Panicos Demetriades's picture Panicos Demetriades University of Leicester Strongly oppose Extremely confident
The ECBs mandate is price stability - that’s not consistent with 4% inflation. To change the mandate requires an amendment of the EU treaty which has to be a unanimous decision by member states. Not in a million years would Germany agree to that.
Ugo Panizza's picture Ugo Panizza The Graduate Institute, Geneva (HEID) Support Not confident

Question 3

Participant Answer Confidence level Comment
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Agree Confident
Jumana Saleheen's picture Jumana Saleheen CRU Group Strongly agree Extremely confident
The EU is a large open economy, with a flexible exchange rate. That means that in response to a negative demand shock, one might see a negative output gap with no weakness in inflation. This arises because of a fall in the exchange rate (in response to the demand shock), which in turn pushes up on import prices and headline inflation rates. It is for this reason that standard RBC models (e.g. Clarida, R, J Gali and M Gertler (1999)) include a traditional Taylor Rule - where optimal policy is determined by the neutral rate of interest and the deviation of inflation from target, and the deviation of output from potential (the output gap).
Jagjit Chadha's picture Jagjit Chadha National Institute of Economic and Social Research Disagree Confident
What it can do better is to place some weight on excessive output volatility and so smooth any return to the inflation target. This implies not so much a secondary aim or target but recognition of the need to avoid sharp employment fluctuations in the Euro Area in aggregate. There may of course be quite sharp output or employment variations in any one country which will not be the responsibility of the ECB.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Neither agree nor disagree Not confident at all
This is difficult. Ideally the answer is yes, but with a very heterogeneous currency zone this would be very difficult and put quite a bit of pressure on the ECB
Michael McMahon's picture Michael McMahon University of Oxford Disagree Confident
I think the current mandate in the Treaty is sufficient to allow concern for issues of economic growth and unemployment to be important in the decision-making of the ECB. The issue is that the flexibility around tolerable inflation is not clearly laid out so it is possible to argue price stability, the primary mandate, is not achieved unless inflation is tightly held around 1.6%. A symmetric target would allow more definite bands in which flexibility could be shown and attention shifted to the secondary mandate.
David Cobham's picture David Cobham Heriot Watt University Strongly agree Very confident
It's important this remains the secondary aim, but explicitly recognising it as such would have positive effects on expectations of policy and on the reputation of the ECB.
Wendy Carlin's picture Wendy Carlin University College London Neither agree nor disagree Confident
The existing ECB official objective can be interpreted this way. But the main problem is the heterogeneity of member country economic performance - recall the divergent performance of members prior to the global finance crisis. With some countries booming and others stagnating, it is not clear how a true dual mandate could work in the eurozone.
Francesca Monti's picture Francesca Monti Kings College London Agree Confident
Lars E O Svensson's picture Lars E O Svensson Stockholm School of Economics Agree Very confident
More precisely, I would prefer to formulate the objective of ECB’s monetary policy as “price stability and full employment without prejudice to the price-stability objective,” where “without prejudice...” is clarified to mean that average inflation over a period such as 4-5 years shall be close to a symmetric inflation target of 2%. As argued in section 2.1 of a paper in the Vitor Constancio Festschrift, https://larseosvensson.se/files/papers/the-future-of-monetary-policy-and-macroprudential-policy.pdf , this is fully consistent with the Treaty on the Functioning of the European Union, Article 127(1), as well as with clarifications of the objective on the ECB's website.
Pietro Reichlin's picture Pietro Reichlin Università LUISS G. Carli Agree Confident
The problem with the dual mandate is that the ECB is the only central bank in the world that is not backed by a state and a political authority. This exceptional degree of independence of unelected officials requires strong constraints on their policies, but it should not prevent monetary policy to respond to EMU wide business cycles. Ideally, unemployment and growth targets should be left to national governments. However, there are many reasons why counter-cyclical fiscal policies are bound to be less effective in the EMU. Among these are the limited fiscal space of some countries (exacerbated by fear of speculative attacks on sovereign debts) and the non internalized EMU wide benefits of national expansionary policies. Hence, strict adherence to the single mandate is dangerous and not realistic. Progressing toward a political union where federal institutions attain more legitimacy may overcome the conflict between independence and dual mandate.
John Hassler's picture John Hassler Institute for International Economic Studies (IIES), Stockholm University Strongly agree Extremely confident
Antonio Fatás's picture Antonio Fatás INSEAD, Singapore Strongly agree Extremely confident
Chryssi Giannitsarou's picture Chryssi Giannitsarou University of Cambridge, Faculty of Economics Agree Confident
Fabrizio Coricelli's picture Fabrizio Coricelli Paris School of Economics Strongly agree Very confident
Ricardo Reis's picture Ricardo Reis London School of Economics Disagree Very confident
First, the "economic policies in the Union" are broader than unemployment. Especially important for a central bank is the integrity of the euro-area, financial stability, and the capital market union. Second, in practice, the ECB has shown its current mandate is consistent with acknowledging trade-offs between inflation and real activity. Third, such a strong shift to unemployment as a dominant goal (as the Fed set in its review) risks re-living the mistakes of the 70s.
Kevin Hjortshøj O'Rourke's picture Kevin Hjortshøj... Oxford University Agree Confident
Kate Barker's picture Kate Barker British Coal Staff Superannuation Scheme Strongly agree Extremely confident
Philippe Bacchetta's picture Philippe Bacchetta Université de Lausanne Agree Confident
Sir Charles Bean's picture Sir Charles Bean London School of Economics Strongly agree Confident
Simon Wren-Lewis's picture Simon Wren-Lewis University of Oxford Strongly agree Extremely confident
I would go further, and make economic growth the primary target subject to achieving an inflation target within some time horizon.
Cédric Tille's picture Cédric Tille The Graduate Institute, Geneva Agree Confident
Evi Pappa's picture Evi Pappa European University institute Neither agree nor disagree Confident
European countries are very heterogeneous, labor market institutions, the role of the government and the sensitivity of the private sector to changes in the interest rate are not comparable across countries. Monetary policy is supposed to be neutral in the long run, so I cannot see how growth can be a secondary objective. Of course, in the current conditions the shock is common and any policy to lift the euro area economy away from recession should be welcome, but it should not become a rule, rather than an exception given the current circumstances. Regional fiscal policy is a better tool to accomplish unemployment and growth objectives.
Benjamin Moll's picture Benjamin Moll London School of Economics Agree Confident
Yes I think that a mandate of this type or even a US-style dual mandate would likely result in better economic outcomes for the Eurozone economy. Monetary policy is a flexible policy tool with a potentially powerful effect on real outcomes like unemployment, GDP etc so why not partially use it to this end?
Linda Yueh's picture Linda Yueh London Business School Agree Confident
Costas Milas's picture Costas Milas University of Liverpool Agree Confident
It would probably help not least because it would calm down tensions between "hawks" and "doves". IMF data suggests that between 1999 and 2019, the Euro area recorded an average annual GDP growth of 1.44%. The 1999-2019 volatility of annual GDP growth was an alarming 1.77%. So recognising economic growth in the ECB mandate would hopefully reduce economic volatility (to say the least).
John VanReenen's picture John VanReenen London School of Economics Agree Not confident
Harris Dellas's picture Harris Dellas University of Bern Strongly disagree Very confident
Jean Imbs's picture Jean Imbs Paris School of Economics Disagree Very confident
Lucio Sarno's picture Lucio Sarno Cass Business School Disagree Confident
Gernot Müller's picture Gernot Müller Eberhard-Karls-Universität Tübingen Disagree Confident
Roger Farmer's picture Roger Farmer University of Warwick Neither agree nor disagree Extremely confident
Robert Kollmann's picture Robert Kollmann Université Libre de Bruxelles Neither agree nor disagree Not confident
This might make the job of the ECB too "political" and contentious. It seems better to keep the simple price stability mandate. We all know that, in crisis times, we can trust the ECB to fight for growth and employment. Just think of Draghi's "whatever it takes" speech.
Panicos Demetriades's picture Panicos Demetriades University of Leicester Strongly agree Extremely confident
It already has! They just need to make it more clear in the Governing Council’s statements.
Ugo Panizza's picture Ugo Panizza The Graduate Institute, Geneva (HEID) Agree Confident