ECB Could Be About to Demolish a Key Pillar of Its Policy Design
Growth in the amount of money in circulation has proven to be a poor guide to inflation, officials said.
(Bloomberg) -- The European Central Bank may consider downgrading or jettisoning a key element of the Bundesbank-inspired architecture of its monetary policy, according to euro-area officials.
Growth in the amount of money in circulation -- one of the ECB’s two “pillars” of analysis to assess the economy -- has proven to be a poor guide to inflation, the officials said, asking not to be identified citing matters for discussion. Focusing on credit being issued or the impact of monetary policy on financial stability might be more appropriate, they said.
The debate highlights how a strategic review to be launched by new President Christine Lagarde will, in her words, “turn each and every stone.” It will evaluate the central bank’s inflation goal -- the ECB’s primary mandate -- and how to reach that, along with broader issues such as climate change and digital currencies.
The review will likely be formally agreed by the Governing Council in January, the officials said, echoing comments made by Lagarde last week. No decisions have yet been made on how the exercise will be structured, they said.
The Monetary Policy Committee, a panel of officials from the ECB and euro-area central banks, is likely to take the lead, the people added.
An ECB spokesman declined to comment on the status of the review and its parameters.
Ditching or downgrading monetary analysis would be a major technical change. It would also be a symbolic overhaul, cutting one of the longest-lasting ties to the Bundesbank, the model for much of the ECB’s design. The German central bank set a money-supply target to control inflation from the mid-1970s until it ceded responsibility for monetary policy a quarter-century later.
The underlying principle is that the buildup of money in the economy -- as notes and coins, bank deposits and short-term money-market instruments -- affects future prices. The faster money supply grows relative to economic output, the greater the risk of accelerating inflation.
Distorted Signals
The usefulness of that principle has been doubted by central bankers for a long time though. For example, euro-area money supply climbed in 2001 even as inflation weakened in the aftermath of the dotcom bust and later the Sept. 11 terror attacks on the U.S. Otmar Issing, the ECB’s chief economist at the time, later said those were “distorted signals” as investors fled to the safety of liquid assets.
Since 2014, the ECB has managed to bolster money supply growth by pumping massive amounts of liquidity into the economy with its bond-buying program, long-term loans to banks, and negative interest rates. Yet inflation has remain stubbornly subdued.
Monetary analysis may still have its fans, not least at the Bundesbank. Its president, Jens Weidmann, declared in 2017 that monetary and credit aggregates are “good indicators of financial imbalances.”
“The second, monetary pillar of the Eurosystem’s monetary policy strategy has therefore lost none of its importance,” he said in a speech. “This is particularly true as monetary developments can provide valuable additional information for the economic analysis of the Eurosystem.”
The declining role of monetary analysis has been a long time coming however. It was downgraded in 2003, the last time the ECB had a comprehensive review, when the Governing Council decided to stop calling it the “first pillar” of its strategy. Instead, the statement read out by the president after each policy meeting dealt with the other pillar -- economic analysis -- first.
--With assistance from William Horobin, Piotr Skolimowski, Carolynn Look and Jana Randow.
To contact the reporters on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net;Alessandro Speciale in Rome at aspeciale@bloomberg.net
To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Craig Stirling
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