ECB's Asymmetric Inflation Target: A Critique of European Central Bank's Policy Approach

Strategic Insights -

The European Central Bank's (ECB) definition of price stability, specifically an inflation target band of 0-2%, has been criticized for being too wide and potentially leading to an asymmetric monetary policy. This approach, coupled with the ECB's independence and accountability issues, has raised concerns about the bank's ability to support economic growth in the euro-zone. Members of the European Parliament's monetary affairs sub-committee may find the following points useful for their next meeting with ECB President Wim Duisenberg on April 19.

Key Takeaways:

  • The ECB's inflation target band of 0-2% is unusually wide, making it difficult to pinpoint the moment when price stability has been reached.
  • This wide band may lead to an asymmetric monetary policy, where the central bank is more likely to pursue a restrictive policy than an expansionary one.
  • An asymmetric inflation target can result in a hawkish central banker always being correct, while a more symmetrical target would provide equal chances of landing above or below the inflation rate.
  • The ECB's approach may be more suitable for an inflationary environment, but its operating environment in the euro-zone is characterized by low inflation and high unemployment rates.
  • European central bankers often attribute unemployment as "overwhelmingly" structural, despite evidence to the contrary, which may be due to their neutral view of monetary policy's impact on unemployment.
  • Cyclical unemployment, caused by swings in the business cycle, is significant in the euro-zone, and its elimination would reduce unemployment rates.
  • A more balanced approach to defining price stability, considering both price stability and economic growth objectives, might be more suitable for the ECB's mandate.

Statistics:

  • The ECB's inflation target band is 0-2%.
  • In December 1998, the inflation rate was 0.8%, which is consistent within the target band.
  • Cyclical unemployment in the euro-zone is estimated to be around 3%.
  • Structural unemployment in the euro-zone is higher than in the US.
  • The euro-zone's unemployment rate was around 12% in the referenced period.
  • Inflation in the euro-zone is heading towards zero.

Sources:

  • Financial Times Limited, 1999
  • European Central Bank (1998) - ECB's inflation target band and definition of price stability
  • European Parliament's monetary affairs sub-committee (1999) - focus areas for the next meeting with ECB President Duisenberg