The Monetary Policy Strategy of the ECB Reconsidered: Monitoring the European Central Bank 5
Author(s): Jordi Galí, Stefan Gerlach, Julio J. Rotemberg, Harald Uhlig, Michael Woodford
Publication Date: 27 Feb 2004
ISBN: 1 898128 73 1
As one of the world?s key central banks, the European Central Bank comes under intense public scrutiny. Yet, its constituency is diverse, with different national traditions of central banking and varied views about the conduct of monetary policy. The ECB acts on behalf of all the members of EMU, but belongs to no particular member state. It is accountable to the European Parliament, which has only a very recent tradition of oversight of monetary policy. For these reasons, there is a need for a regular, rigorous, non-partisan and pan-European analysis of the options facing the ECB and the policies it pursues. Monitoring the European Central Bank addresses this need. Written by a team of distinguished academic economists known internationally for their work on macroeconomics and monetary policy, MECB produces a full report and an Update each year. The full report describes the issues faced by the ECB during the preceding year; assesses the policy choices that were made; and sets out the issues likely to arise during the coming year. The Update offers a follow-up to the main report, and is written in the light of the Bank?s own annual report. This year's report, the fifth in the MECB series, investigates the 'Duisenberg record' and the recent review by the ECB of its monetary policy strategy. It finds that the ECB has failed to achieve its stated key objective of avoiding inflation in excess of 2%. Tough rhetoric without delivery has been a strategic mistake. Actual inflation appears to be adrift due to inattentive policy. This could lead to a dangerous and costly-to-correct climb in the inflation rates, unless sufficient attention is paid soon to this issue by the ECB. The ECB should have used its review of the monetary policy strategy to admit this failure and to adjust its inflation target range upwards, bringing words in line with actual policy. It did not, and stresses continuity instead. Money still continues to play too prominent a role in the ECB's stated strategy. The report examines several of the arguments often given for a prominent role of money, and finds none of them convincing. Inflation at present and in the future should be the central focus of the ECB's analysis, not money growth rates. Deflation is a risk that is always present when inflation is low. The ECB should admit this rather than avoid talking about it. The ECB can mitigate this risk by promising to keep interest rates at zero for as long as is necessary if the economy ever enters a period of deflation. The usual fears of deflation are exaggerated. There may be good reasons for the ECB not to aim at a near-zero inflation rate, but the risk of deflation is not one of them.