The ECB does not change its monetary strategy but offers three important points for reflection

The European Central Bank has just published the latest revision of its monetary policy strategy. As expected, there are no radical changes but rather confirmations of choices that have largely already been made. However, at least three interesting points emerge to reflect on.

The first is that the ECB does not intend to give the markets very precise indications about its next moves, downward or upward, in interest rates. This may disappoint those operators and commentators who believe that the Central Bank should announce its decisions well in advance and not take the markets by surprise. However, if the ECB were to comply with this request, it would risk, in a context of high uncertainty, being dragged into continuous communication, which would inevitably reduce the relevance of the message. This would consequently undermine its credibility. Financial markets will therefore have to make the effort to develop their own forecasts, in the knowledge that, ultimately, the Central Bank will act with the priority objective of combating inflation.

The second point, partly linked to the first, concerns the Central Bank's intention to enrich its analysis with a certain number of alternative scenarios, to simulate more extreme evolutions of the macroeconomic framework. While the use of scenarios for internal purposes can be useful, in particular to understand the effect of any forecast errors, it is not clear how this can improve the decision-making process and especially the external communication of the Central Bank. If econometric models have proven to be fragile in the past, especially for making forecasts, they risk being even more imprecise in the simulation of extreme shocks, which are unprecedented in historical experience. It is therefore not obvious that the publication of these scenarios adds useful information for understanding monetary policy and does not, on the contrary, risk adding further fog to communication.

The third point concerns a key word used in the document, which refers to the force (or power, in English forcefulness) with which the central bank intends to react to significant and persistent deviations of inflation from the 2 percent target . It is not clear, in particular, what this intention consists of. The document refers to the measures implemented in the last decade by the same Central Bank, both when inflation was excessively low and when deflationary pressures prevailed, as in the period 2014-2018, and when inflation increased strongly, as in 2021-22. However, with hindsight, those measures, and the ways in which they were implemented in both circumstances, can hardly be characterized as strong or powerful.

In the past decade, for example, faced with very low inflation rates and deflationary risks, the ECB played for a long time with measures that proved ineffective, such as negative interest rates and announcements on the evolution of rates (the so-called forward guidance), before finally deciding, at the beginning of 2015, to buy – at that point, with force and determination – government bonds of member countries (the so-called Quantitative easing) to increase the amount of money in circulation, as the US Federal Reserve had done since 2008. The hope, should a new deflationary risk arise, is that the ECB will quickly resort to the most effective instrument, without first having to reduce interest rates to negative levels.

As for the most recent inflationary experience, in 2022, monetary tightening was delayed by the ECB's commitment to the markets to first end its market purchase policy. Interest rates were only increased at the end of July 2022, after eight years of negative rates, when inflation had already exceeded 8 percent. The persistence of interest rates below expected and forecast inflation and government bond purchases contributed to fueling inflationary pressures in 2022. Here too, we can expect the central bank to act more quickly and with greater determination to combat inflation in the future and not tie its hands with commitments that risk proving counterproductive.

In any case, beyond the more or less new strategies and commitments, the old English saying about the quality of the pudding also applies to monetary policy, according to which one can only give a true judgement after having eaten it.

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