A James Alexander post
In a few decades, if the European monetary union experiment has failed, the gravestone will be marked with the utterly depressing and anti-stimulative inflation objective of “Below, but close to, two percent”.
You just knew the press conference after the ECB meeting this week was going to go badly when Draghi intoned the dreaded six words in the second paragraph of his opening statement. This was a record for the year in fact. My analysis shows that normally it is in the third paragraph, and at the last two press conferences it was rather excitingly relegated to the sixth and seventh paragraphs. There can be no convincing recovery in the Euro Area while there is an inflation ceiling like this.
Scott Sumner has already opined on the undoubted tightening of monetary policy today as markets reacted negatively: the Euro currency strengthened and stocks fell. He also correctly points out that expectations were running high.
However, the data from the rear view mirror isn’t too bad if you look at base money or NGDP growth. Draghi pointed out the strong growth of M1 at 11% before launching into the newer central bank creed of creditism. Loans were much cheaper, following bond yields down.
Of course, true success for his monetary easing would be bond yields rising. Ironically, on the day yields did rise. But this was more due to the disappointment of no additional QE bond buying rather than any additional hopes for a recovery. A sort of reverse liquidity effect (ie bonds had been overbought and fell back in price) rather than any Fisher effect (where higher nominal growth expectations cut the real return on bonds and their prices fall).
A growing debate on changing the mandate of the ECB
I am still looking for silver linings and was very interested to see this policy report from a pro-European think tank, the Centre for European Reform, with a very heavyweight Advisory Board of VSPs. The author, Christian Odendahl, recommends ending national monetary influences in the ECB Board – a great idea and one we alluded to recently. But even more he recommends investigating targeting a higher inflation rate, a level target and even Aggregate Demand.
A stable level of demand is crucially important in a monetary union, as excessively low demand can lead to regional depressions and soaring debt, destabilising the whole union in the process. The European Central Bank (ECB) has failed to maintain the necessary level of demand and inflation during the course of the eurozone crisis, and needs a stronger mandate to prevent this from happening in the future. Such a mandate should include a higher and symmetrical inflation target, as well as the explicit responsibility for maintaining an adequate level of demand. National central banks should no longer be involved in eurozone monetary policy, since they tend to politicise decisions along national lines.
Ideally, therefore, the ECB should be given a more robust and activist mandate to manage demand.
This mandate should include:
« A higher inflation target of 3 per cent so that interest rates can be lowered more in the event of a crisis.18
« An explicit commitment that this target be symmetrical, so that undershooting and overshooting the target are of equal concern.
« A provision to take overall demand into account, rather than just inflation. In 2011, for example, inflation rose but demand was weak – and the ECB made the wrong decision to raise interest rates, which weakened demand further. In such a situation, preference should not be given to inflation.
Odendahl also included a great, Marcus Nunes-style chart showing the colossal failure of the ECB to properly manage Aggregate Demand, aka Nominal GDP.
Odendahl referred readers to the recent European Parliament hearing on NGDP Targeting. A draft of just one of the papers had found its way onto various blog sites but the link shows there were in fact three papers presented. I have reproduced all three abstracts of the final papers.
It is both fascinating and hopeful that academics from leading German, French and British economics departments were represented even if only one (can you guess which?) was clearly in favour. The two others were sympathetic but did go off on some strange tangents. One favoured flexible inflation targeting and thought NGDP targeting wouldn’t help central banks with their central problem of “financial stability”. The third favoured a complex amendment to the Taylor Rule.
We seek to clarify whether or not nominal GDP targeting (NGDP) may be a suitable tool for the ECB’s monetary policy. We argue that this question really consists of three distinct but related questions: (1) Is it better for the ECB to put more weight on output than it does currently, by switching to a NGDP target? (The theoretical evidence suggests, maybe, but this depends on the distortions faced by the economy.) (2) Should a NGDP (or inflation) target be formulated in rates of growth, or in levels? (The theoretical evidence suggests that a levels target may have some appealing properties, by stabilizing expectations.) (3) What technical issues remain to be addressed? (Issues include the selection of an operating instrument, difficulties in estimating trends, data revisions, and communication.) Altogether, we argue that thinking about nominal GDP targeting in this way might help to clarify what is otherwise a confusing debate.
(Wolfgang LECHTHALER, Kiel Institute for the World Economy; Claire A. REICHER, Kiel Institute for the World Economy; Mewael F. TESFASELASSIE, Kiel Institute for the World Economy)
We assess the pros and cons of nominal GDP targeting vis-à-vis flexible inflation targeting regime. We show that the benefit of a regime shift towards nominal GDP targeting in the euro area might be small. Moreover, nominal GDP targeting is not concerned with financial stability. Finally, targeting nominal GDP would make ECB communication very difficult. If the aim of a regime shift were to bring the ECB to pay more attention to growth, it would be more straightforward to fix a dual mandate and to set an explicit target for real output growth or the unemployment rate.
(Christophe BLOT, OFCE/Sciences Po; Jérôme CREEL, OFCE/Sciences Po and ESCP Europe; Xavier RAGOT, OFCE/Sciences Po, CNRS and PSE)
The idea of targeting smooth growth for nominal income (GDP), as an alternative to the conventional Taylor or inflation targeting rules for setting monetary policy, has been in discussion for many years. But they have never been used in practice. In this paper we review the pros and cons of adopting such an approach, and find them to be rather finely balanced. To dig deeper, we consider certain particular features of nominal income targeting: the crucial role of supply side responsive- ness (nominal income targeting substitutes for poor responses or a lack of market or structural reform); the need to bring market forces into play; the question of whether income targeting increases discipline; and the extra constraints imposed by having a dual mandate. The upshot is that nominal income targeting emerges as a special case of the more flexible Taylor rule formulation, although it does generalise on pure inflation targeting. In practice the Taylor rule form may be improved by using time varying, state contingent coefficients. De facto, this is what the ECB has done in recent years. The simulation studies available suggest that the more flexible rules of this kind perform better in reducing the fluctuations of output and inflation away from target; and are, crucially, more robust to model uncertainty (important for design) and real-time data/information errors (important in implementation).
(Andrew HUGHES HALLETT, School of Economics and Finance, University of St Andrews, Scotland)