The ECB Weighs a Profound Shift in Policy

(Bloomberg Opinion) -- Think about extravagant campaign promises, and the words “policy review” don’t exactly leap to mind. And yet, in the steady-as-she-goes world of central bankers, Olli Rehn’s call for a comprehensive rethink of the European Central Bank’s objectives has galvanized the race to succeed Mario Draghi.

The ECB president steps down at the end of October and Rehn, governor of the Bank of Finland, is a contender to replace him. The list also includes Jens Weidmann, president of Germany’s Bundesbank, and the Banque de France’s Francois Villeroy de Galhau (who’s just become favorite, according to a Bloomberg poll of economists).

Rehn hasn’t confirmed that he’s running for the job but his call for a policy review – including a possible rethink of the ECB’s target of having inflation below but close to 2% – has a distinct whiff of the electoral hustings. The Finn knows plenty about politics: He has been a lawmaker and finance minister at home, and a two-time European Commissioner, including during the euro zone debt crisis when he was in charge of economic and monetary affairs.

Putting campaigning to one side, asking whether the ECB should revamp its targets and operations is an interesting question, albeit a tricky one. It will certainly be raised when political leaders meet to discuss Draghi’s replacement. Peter Praet, the ECB’s departing chief economist, warned this week that the bank’s officials shouldn’t launch a review lightly. “When you announce it in public, it can be misread,” he said at a Financial Times event in Frankfurt. Investors might try to second-guess what result the ECB has in mind, such thinking goes, and that would impact the currency and bond markets.

Nevertheless, this might indeed be the moment for the euro zone’s central bank to reexamine its objectives. For a start, it’s 20 years since the launch of the single currency and 16 years since the ECB last updated its strategy – long enough to consider a fresh approach. The U.S. Federal Reserve has just embarked on a similar exercise, which will report back in the first half of 2020. The Fed is still the most important central bank in the world, so it makes sense for the ECB to make a move after its sees what the Americans choose to do.

Unlike the ECB, whose mandate is primarily to maintain price stability, the Fed has dual objectives that also include the delivery of maximum employment. These are set by the U.S. Congress and, as such, are excluded from the review. But the Fed may decide there are better ways to meet its 2% inflation target, including changing the way it communicates its thinking.

Regardless of what the Fed does, a policy change might help the ECB to answer those critics who say it has run out of weapons to fight the next recession. These fears are largely misplaced: The biggest risk is that the bank’s next president is unwilling to use the available tools. But in the past five years, the ECB has often undershot its slightly less than 2% inflation target, despite releasing a deluge of cheap money. It makes sense to look for a more effective way to promote growth.

Indeed, there’s a straightforward change that the ECB should start with: Setting the inflation target at a hard 2% so that there’s no deflationary bias in it. This change would bring the bank closer to other major monetary institutions, including the Fed and the Bank of England, and remove a degree of arbitrariness from the actions of the next president. The current “below, but close to” 2% formulation can mean anything from 1.6% to 1.9%, implying different paths for monetary policy. A firm 2% target would also show that the ECB cares more than it has done so far about periods of slow price growth.

Even such a minor-looking tweak would be hard to shepherd in politically and could incense the inflation hawks at Germany’s Bundesbank and elsewhere. The change might not be enough by itself to boost inflation and growth. After all, saying you’re aiming for 2% doesn’t mean you’ll get there.

But if the ECB is to conduct a policy review, this would be a useful shift in direction. Whomever succeeds Draghi – whether that’s Rehn or someone else – would be wise to consider it.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

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 Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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