Jay Powell Sets the Pace for Christine Lagarde

The European Central Bank is often accused of being one step behind the U.S. Federal Reserve when fighting recessions. The Fed’s decision to revamp its monetary policy this week might leave the ECB looking off the pace again.

The changes — which include moving to targeting an average rate of inflation — are hardly relevant in today’s world, in which central banks are well below their aim. Yet they signal how far policy makers are willing to go to lift growth. As the ECB prepares for its own policy overhaul, it shouldn’t become the eternal laggard.

There are two main differences between the ECB’s and the Fed’s monetary policy regimes. For a start, the former’s focuses primarily on price stability and — only subject to that — takes into account employment and other objectives. Conversely, the Fed has a “dual” mandate on inflation and unemployment. Second, ECB policy makers aim for a rate of inflation “below but close to” 2%, as opposed to the Fed’s straight 2% target.

Fed Chairman Jay Powell has now revamped the U.S. objectives in two important ways. For starters, the central bank announced it will seek to keep “average” inflation at 2%, meaning it will tolerate periods of slightly faster price growth to compensate for past episodes of inflation undershooting. It will also not tighten monetary policy on the back of very low unemployment, unless this is undermining price stability.

Both these changes suggest the Fed will be more patient about raising rates. In theory, they also make the Fed look much more interested than the ECB in supporting the economy for a long time.

In practice, these differences aren’t so large. Inflation is hardly a problem right now, as the pandemic takes its toll on the economy and constrains severely the growth of wages and prices. As a result, both the Fed and Christine Lagarde’s ECB have slashed interest rates to record lows and unleashed large and flexible programs of asset purchases. The Fed’s pledge to keep inflation above 2% is a tad quixotic, too, as it’s not clear how it can even get to 2% in a sustained manner.

Moreover, the ECB isn’t overly strict about its objectives. Its officials have made it clear that their target of “below but close to 2%” is not a ceiling. This means the central bank will be patient about raising rates and ending asset purchases, since it’s equally concerned about inflation being below target or above it. Moreover, since the presidency of Mario Draghi, the ECB has placed more emphasis on employment. It’s hard to imagine that it would pursue a different monetary policy even if it had a Fed-like dual mandate.

Still, as the Fed moves it would be wrong for the ECB to stand still. The euro zone’s central bank has delayed its own policy review, the first in nearly two decades, because of the pandemic. The Fed has shown it is possible to fight today’s war while preparing for the next one. As I’ve argued before, the ECB should move to a straight 2% target, which would clarify the central bank’s aims.

It could also consider a move to an average inflation target, but policy makers should be careful about the drawbacks of this approach. Were inflation to go above 2%, central bankers could come under pressure to renege on their earlier promises and tighten policy. That would make their initial commitment less credible.

The ECB has come a long way since the introduction of the euro. During the pandemic, it has been as flexible and creative as the Fed. It’s time to put some of these changes in writing. The sooner policy makers do it, the better.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

©2020 Bloomberg L.P.

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