Social Europe

  • EU Forward Project
  • YouTube
  • Podcast
  • Books
  • Newsletter
  • Membership

ECB strategy review: the mountain has given birth to a mouse

Peter Bofinger 26th July 2021

Peter Bofinger argues that the ECB strategy review represents a missed opportunity.

ECB strategy review,Lagarde,inflation targeting
Peter Bofinger

High expectations accompanied the outcome of the European Central Bank’s strategy review, presented earlier this month. Already at her first press conference in December 2019, the ECB president, Christine Lagarde, had insisted that ‘that strategic review needs to be comprehensive, needs to look at all and every issue, will turn each and every stone’.

Considering that the core of the previous strategy dated back to 1998 and betrayed considerable weaknesses at the time, the need for a thorough review was beyond doubt. But after the presentation of the results on July 8th, it is not obvious that it represents the ‘pretty strong step’ Lagarde suggested.

Incremental, not fundamental

At the heart of the matter for the ECB is the definition of the mandate of price stability. The new strategy has replaced the somewhat awkward ‘below, but close to, 2 per cent’ from the 2003 strategy review with a cleartarget of 2 per cent—with explicit reference to the symmetry (an average, not a ceiling).

This is helpful but more an incremental than a fundamental change. Inflation forecasts by the Survey of Professional Forecasters (SPF) since 1999 indicate that from the outset the ECB’s target was regarded as a value close to 2 per cent (Figure 1). This was even true for the original target definition of ‘below 2 per cent’, replaced in 2003. Since 1999, the average of the inflation forecasts five years ahead has been 1.88 per cent, which is as close to 2 per cent on the underside as possible.

Figure 1: inflation forecasts for the euro area

ECB strategy review,Lagarde,inflation targeting
Source: Survey of Professional Forecasters

The symmetry of the target is also less revolutionary than it appears. The emphasis on the ‘medium-term’, already included in the 1998 target definition, makes clear temporary deviations upwards and downwards are possible. Moreover, in March 2016 Lagarde’s predecessor, Mario Draghi, had already declared that the bank’s Governing Council understood the target symmetrically:

What I can say, however, is that our mandate is defined as reaching an inflation rate which is close to 2 per cent but below 2 per cent in the medium term. Which means that we’ll have to define the medium term in a way that, if the inflation rate was for a long time below 2 per cent, it will be above 2 per cent for some time. The key point is that the Governing Council is symmetric in the definition of the objective of price stability over the medium term.



Don't miss out on cutting-edge thinking.


Join tens of thousands of informed readers and stay ahead with our insightful content. It's free.



That ECB-watchers were aware of this symmetry is reflected in the probability distribution of longer-term inflation expectations, such as in the SPF forecast for the second quarter of 2016 (Figure 2).

Figure 2: aggregated probability distribution of longer-term (five years ahead) inflation expectations

ECB strategy review,Lagarde,inflation targeting
Source: Survey of Professional Forecasters

Empty of content

The ECB rightly contends that a strategy should ‘provide(s) policymakers with a coherent analytical framework that maps actual or expected economic developments into policy decisions’, as well as a vehicle for public communication. That framework must thus play a prominent role. The ECB has replaced the ‘two-pillar strategy’ from 1998 with an ‘an integrated assessment of all relevant factors’—an economic analysis and a monetary and financial analysis.

Beyond rather tautological statements, the ECB elaborates the rationale in these words:

Within this framework, the economic analysis focuses on real and nominal economic developments, whereas the monetary and financial analysis examines monetary and financial indicators, with a focus on the operation of the monetary transmission mechanism and the possible risks to medium-term price stability from financial imbalances and monetary factors. The pervasive role of macro-financial linkages in economic, monetary and financial developments requires that the interdependencies across the two analyses are fully incorporated.

Thus, the analytical framework continues to be as empty of content as it was in 1998. If a strategy is to contribute to a better understanding of a central bank’s decision-making it must offer some heuristic, reducing the complexity of reality to some simple rules of thumb or cues. While monetary targeting and the Taylor rule both came close to a heuristic, they failed in practice. In contrast, inflation targeting has functioned pretty well and is now practised by many central banks in advanced and emerging-market countries.

Such a strategy reduces the complexity of monetary-policy decisions by focusing on inflation forecasts. By comparing forecasts with the inflation target, undesirable developments and the need for monetary-policy action can be identified in good time. Several independent institutions produce inflation forecasts for the euro area (Figure 3), which can render the analytical framework more objective. Due to the different forecast horizons, temporary shocks leading to temporary deviations from the target can also be identified and explained.

Figure 3: inflation forecasts for the euro area (Q3, 2021)

ECB strategy review,Lagarde,inflation targeting
Source: Survey of Professional Forecasters

The ECB has missed the opportunity to develop its strategy towards explicit inflation targeting, as recommended by prominent economists (‘targeting inflation is very close to what the ECB has been doing—regardless of the rhetoric—and to what it should be doing’) from the very beginning. This is even more surprising as the bank practised implicit inflation targeting in the past: in the introductory statements to its press conferences, the detailed SPF inflation forecasts were prominently mentioned.

Public communication

The new strategy was implemented with a press conference on July 22nd. The ‘introductory statement’ was replaced by a ‘monetary policy statement’. This was supposedly ‘more narrative-based, and more concise’ but it is not obvious it has improved communication with the public.

The absent SPF inflation forecasts of 1.5 per cent for the medium-term and 1.8 per cent for the long-term would have justified the ECB’s expansionary stance, while reassuring the public that price stability was not endangered. But Lagarde insisted the Governing Council was ‘not relying on any kind of projections’. Without concrete data, however, the ‘narrative’ is less informative and also not correct: Lagarde said the bank expected inflation to ‘rise over the medium term’, when a decline is forecast in 2022 and 2023.

A further drawback is the neglect of monetary data. Although monetary growth is only very indirectly related to inflation, the 8.4 per cent growth rate of the money stock, M3, is still very high and requires attention. With the unprecedented increase in the ECB’s balance sheet, many citizens are concerned this might lead to an upsurge of inflation.  

The focus of the press conference was Lagarde’s presentation of the implications of the strategy review for the forward guidance on the key ECB interest rates:

The Governing Council expects the key ECB interest rates to remain at their present or lower levels until we see inflation reaching 2 per cent well ahead of the end of our projection horizon and durably for the rest of the projection horizon, and we judge that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at 2 per cent over the medium term. This may also imply a transitory period in which inflation is moderately above target.

After this mouthful, Lagarde had to admit: ‘I know that it’s going to take a little time to unpack it and really understand all the subtlety and the details of it.’ But if the ECB is committed to improving its communication ‘towards the wider public, which is essential for ensuring public understanding of and trust in the actions of the ECB’, why choose such cryptic language?

The bank faces a difficult balancing act. On the one hand, it has to make clear to the financial markets that no higher interest rates are to be expected in the foreseeable future. On the other, it must make clear to the citizens of Europe, who fear inflation, that there is no danger to price stability in the medium term. After the recent press conference, one could get the impression that the ECB is addressing the financial markets more than the citizens. This damages its public image—and risks turning public fear of inflation into a self-fulfilling prophecy.

This article is a joint publication by Social Europe and IPS-Journal

Peter Bofinger
Peter Bofinger

Peter Bofinger is professor of economics at Würzburg University and a former member of the German Council of Economic Experts.

Harvard University Press Advertisement

Social Europe Ad - Promoting European social policies

We need your help.

Support Social Europe for less than €5 per month and help keep our content freely accessible to everyone. Your support empowers independent publishing and drives the conversations that matter. Thank you very much!

Social Europe Membership

Click here to become a member

Most Recent Articles

u4219834676 bcba 6b2b3e733ce2 1 The End of an Era: What’s Next After Globalisation?Apostolos Thomadakis
u4219834674a bf1a 0f45ab446295 0 Germany’s Subcontracting Ban in the Meat IndustryŞerife Erol, Anneliese Kärcher, Thorsten Schulten and Manfred Walser
u4219834dafae1dc3 2 EU’s New Fiscal Rules: Balancing Budgets with Green and Digital AmbitionsPhilipp Heimberger
u42198346d1f0048 1 The Dangerous Metaphor of Unemployment “Scarring”Tom Boland and Ray Griffin
u4219834675 4ff1 998a 404323c89144 1 Why Progressive Governments Keep Failing — And How to Finally Win Back VotersMariana Mazzucato

Most Popular Articles

u4219834647f 0894ae7ca865 3 Europe’s Businesses Face a Quiet Takeover as US Investors CapitaliseTej Gonza and Timothée Duverger
u4219834674930082ba55 0 Portugal’s Political Earthquake: Centrist Grip Crumbles, Right AscendsEmanuel Ferreira
u421983467e58be8 81f2 4326 80f2 d452cfe9031e 1 “The Universities Are the Enemy”: Why Europe Must Act NowBartosz Rydliński
u42198346761805ea24 2 Trump’s ‘Golden Era’ Fades as European Allies Face Harsh New RealityFerenc Németh and Peter Kreko
startupsgovernment e1744799195663 Governments Are Not StartupsMariana Mazzucato
u421986cbef 2549 4e0c b6c4 b5bb01362b52 0 American SuicideJoschka Fischer
u42198346769d6584 1580 41fe 8c7d 3b9398aa5ec5 1 Why Trump Keeps Winning: The Truth No One AdmitsBo Rothstein
u421983467 a350a084 b098 4970 9834 739dc11b73a5 1 America Is About to Become the Next BrexitJ Bradford DeLong
u4219834676ba1b3a2 b4e1 4c79 960b 6770c60533fa 1 The End of the ‘West’ and Europe’s FutureGuillaume Duval
u421983462e c2ec 4dd2 90a4 b9cfb6856465 1 The Transatlantic Alliance Is Dying—What Comes Next for Europe?Frank Hoffer

S&D Group in the European Parliament advertisement

Cohesion Policy

S&D Position Paper on Cohesion Policy post-2027: a resilient future for European territorial equity

Cohesion Policy aims to promote harmonious development and reduce economic, social and territorial disparities between the regions of the Union, and the backwardness of the least favoured regions with a particular focus on rural areas, areas affected by industrial transition and regions suffering from severe and permanent natural or demographic handicaps, such as outermost regions, regions with very low population density, islands, cross-border and mountain regions.

READ THE FULL POSITION PAPER HERE

ETUI advertisement

HESA Magazine Cover

With a comprehensive set of relevant indicators, presented in 85 graphs and tables, the 2025 Benchmarking Working Europe report examines how EU policies can reconcile economic, social and environmental goals to ensure long-term competitiveness. Considered a key reference, this publication is an invaluable resource for supporting European social dialogue.

DOWNLOAD HERE

Eurofound advertisement

Ageing workforce
The evolution of working conditions in Europe

This episode of Eurofound Talks examines the evolving landscape of European working conditions, situated at the nexus of profound technological transformation.

Mary McCaughey speaks with Barbara Gerstenberger, Eurofound's Head of Unit for Working Life, who leverages insights from the 35-year history of the European Working Conditions Survey (EWCS).

Listen to the episode for free. Also make sure to subscribe to Eurofound Talks so you don’t miss an episode!

LISTEN NOW

Foundation for European Progressive Studies Advertisement

Spring Issues

The Summer issue of The Progressive Post is out!


It is time to take action and to forge a path towards a Socialist renewal.


European Socialists struggle to balance their responsibilities with the need to take bold positions and actions in the face of many major crises, while far-right political parties are increasingly gaining ground. Against this background, we offer European progressive forces food for thought on projecting themselves into the future.


Among this issue’s highlights, we discuss the transformative power of European Social Democracy, examine the far right’s efforts to redesign education systems to serve its own political agenda and highlight the growing threat of anti-gender movements to LGBTIQ+ rights – among other pressing topics.

READ THE MAGAZINE

Hans Böckler Stiftung Advertisement

WSI Report

WSI Minimum Wage Report 2025

The trend towards significant nominal minimum wage increases is continuing this year. In view of falling inflation rates, this translates into a sizeable increase in purchasing power for minimum wage earners in most European countries. The background to this is the implementation of the European Minimum Wage Directive, which has led to a reorientation of minimum wage policy in many countries and is thus boosting the dynamics of minimum wages. Most EU countries are now following the reference values for adequate minimum wages enshrined in the directive, which are 60% of the median wage or 50 % of the average wage. However, for Germany, a structural increase is still necessary to make progress towards an adequate minimum wage.

DOWNLOAD HERE

Social Europe

Our Mission

Team

Article Submission

Advertisements

Membership

Social Europe Archives

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Miscellaneous

RSS Feed

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

BlueskyXWhatsApp