ECB Credibility Depends on Inflation Flexibility, Nowotny Says
In his policy brief, Nowotny argued the ECB should find a “more realistic and flexible” definition of price stability.
(Bloomberg) --
The European Central Bank must adopt a flexible approach to price stability or risk losing its credibility, according to Ewald Nowotny, whose term as a policy maker ended last year.
The former head of the Austrian central bank is publishing his views just as ECB President Christine Lagarde leads the institution into its first strategic review since 2003. A core debate will be whether to change the definition of price stability as inflation “below, but close to, 2%” -- a target the ECB has fallen short of for years despite controversial stimulus such as bond purchases and negative interest rates.
“I consider it to be dangerous for the credibility of a central bank if it is not able to reach its self-imposed goals for a long period of time,” Nowotny wrote in a policy brief for the Austrian Society for European Politics. “It would be dangerous to ignore rules, but it would also be dangerous to apply rules in a dogmatic way, while ignoring basic economic developments.”
The remarks are similar to comments on Monday by Executive Board member Yves Mersch, who warned that public faith in the central bank has waned since the region’s financial crisis, even though support for the euro has recovered. He said a “prolonged loss of trust in the ECB risks undermining the broad public support” that it needs to remain independent.
In his policy brief, Nowotny argued the ECB should find a “more realistic and flexible” definition of price stability. He suggested a goal of 2% with a range of 1 percentage point either side.
His successor at the Austrian central bank, Robert Holzmann, is a rare voice arguing for a lower inflation aim to reflect trends such as globalization that put downward pressure on prices.
Nowotny ended with a warning that central banks and governments will need to coordinate their monetary and fiscal policies much better come the next crisis if they want to avoid repeating history.
“A policy of ‘benign neglect’ -- of doing nothing on the economic policy front and of waiting for the markets to stabilize themselves -- could lead to economically and politically catastrophic effects,” he wrote. “The developments of the 1930s, especially also in Germany, may be a strong warning signal.”
To contact the reporter on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net
To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Jana Randow, Fergal O'Brien
©2020 Bloomberg L.P.