Mario Draghi’s inflation targets miss the mark

24/1/2016

By Wolfgang Münchau

The ECB keeps failing because it is not fully committed

It looks as though Mario Draghi will get in March what he asked for in December — a further easing of monetary policy. This is welcome. It will allow the European Central Bank president to re-establish his authority — but it will not fully undo the damage caused by the ECB’s failure to act more decisively late last year.

The ECB has got itself into an extraordinarily difficult position. It has missed its policy target — a headline rate of inflation at “close to but below” two per cent — for four years. The target has lost credibility. Once people have lost confidence in an inflation target, it becomes very hard for the central bank to persuade them to trust the target again.

It was touching to hear Mr Draghi last Thursday talk about failing to reach
a goal, then to try again and to fail again. I do not doubt his determination but the minutes of the December 3 meeting of the governing council tell us that not everybody supports the target in the same way. The minutes are anonymous. We know what has been said but not by whom.

What struck me in particular were two specific arguments used by some of the governors against a further increase in the size of asset purchases — part of the programme of quantitative easing aimed at revitalising the eurozone economy.

One said that he would not accept a further increase in QE unless the eurozone was once again in deflation. The implicit message of that statement is that this particular governor’s policy target must be zero per cent, not two per cent. He will only act once prices actually fall.

Another argument was that the positive effects of QE were diminishing over time while the negative side effects, like potential financial instability, were not. This argument is clever but also inconsistent with the policy goal.

It is clever in the sense that it is self-fulfilling: if you choose not to increase the level of QE, then its effects diminish over time. And, of course, when the policy is not working, the adverse side effects may dominate.

The perception of poor support for the policy target also extends to former governing council members, whose spirit still haunts the glistening twin towers of the ECB headquarters in Frankfurt.

One of them is Otmar Issing, a former member of the ECB’s executive board. Mr Issing told Börsen-Zeitung, a German financial newspaper, that it would be right to take longer to reach the inflation target. At the moment the horizon is defined as the medium-term, generally interpreted as two to three years. A longer time would reduce the need for the ECB to act right now.

His comment confirms something I had suspected for a long while but was never able to confirm: he cares if inflation is above the target but less so when it is low. The target becomes asymmetric.

We know that his successor, Jürgen Stark, never believed in it. For him the target was simply price stability with no further qualification let alone numeric definition. It had a certain “we-know-it-when-we-see it” quality, like a former US Supreme Court justice’s definition of pornography.

Jens Weidmann, president of the Bundesbank, is in the same camp as Mr Issing. He never explicitly distanced himself from the ECB’s price stability target but he is clearly unwilling to follow Mr Draghi’s mantra of doing “whatever it takes” to hit it either.

Germany’s economic establishment has its unofficial inflation target, which I would put at a range of 0-2 per cent. If that were the target, no policy action would be needed now.

So when Mr Draghi says, as he did last Thursday, that “there are no limits to how far we are willing to deploy our instruments within our mandate” he is right in a technical sense but that does not tell the whole story if there is a dispute about the mandate.

The December minutes also reveal another problem. Some of the comments — again we do not know by whom — show an extraordinary lack of judgment. For example, at least one governor confidently expressed the view that the slowdown in China and emerging markets was only a blip that one should happily ignore. Subsequent events have shown this optimism to be wildly misplaced.

Another said that the core rate of inflation — which excludes volatile prices like those of oil and food — was finally heading upwards. That was not true. The latest data that were available at the time of the meeting showed that the trend was already reversing. It has reversed further since.

To me this all shows that, as an institution, the ECB is only partially committed to its stated goal. This is one of the reasons why it keeps missing its policy target.

I do not doubt Mr Draghi’s determination, but I have no reason to expect that the governing council as a group will act any differently to the way it did in the past: reluctantly and late.

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