By David Barwick – FRANKFURT (EconoStream) – European Central Bank President Christine Lagarde on Wednesday made clear that the inflation target of the ECB is likely to undergo considerable revision as a result of the recently relaunched strategy review.

In remarks made at the ECB and Its Watchers XXI conference, Lagarde, according to a text made available by the ECB, suggested that changes may be in store for how the objective is worded; for the relevant time horizon, for how inflation is measured; and what the central bank’s standard arsenal should consist of.

The ECB’s ‘below but close to 2%’ definition of price stability ‘was appropriate at a time when the ECB was seeking to establish credibility and too-high inflation was its main worry’, she said. ‘But in the current environment of lower inflation, the concerns we face are different and this needs to be reflected in our inflation aim.’

In particular, making sure standard policy instruments do not lose their meaning requires ‘sufficient space above zero’, while inflation expectations require the underpinning of a symmetrical, readily understood inflation aim.

With respect to the horizon with respect to which monetary policy aims for price stability, Lagarde provided arguments in favour of continuing with a medium-term orientation, but observed that ‘[t]he low inflation environment creates some new questions about how to operationalise’ it.

The ECB’s two-pillar approach, based on analyses of economic and monetary developments, needs reflecting on, she said. The latter ‘could in principle be enhanced to provide information on financial stability which – over longer time horizons – could be relevant for the inflation outlook’, she noted.

While the ECB’s forward guidance already means that the past is implicitly taken into account, the bigger question ‘is whether central banks should commit to explicitly make up for inflation misses when they have spent quite some time below their inflation goals’, she said.

As a way to empower monetary policy up against the lower bound, given that ‘the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates’, she said, ‘the usefulness of such an approach could be examined.’

Lagarde also let it be known that the ECB would revisit the measure of inflation it most relies on, with the goal of reflecting people’s daily costs, perceptions of costs and owner-occupied housing.

‘This is not about moving the goalposts for monetary policy’, she said. ‘It is about future-proofing how we measure inflation.’

She continued: ‘Likewise, to get a better sense of the evolution of the HICP over the medium term, we need to complement our analysis also by looking at more cyclical and less volatile measures of inflation, such as underlying inflation’, which she said is ‘more responsive to economic slack and tend[s] to better predict inflation over the medium term.’

Policy normalisation is commonly understood to mean the unwinding of non-standard measures until monetary policy is again based on interest rates, she observed. However, the new normal of monetary policy could be more like the world before the pandemic or even now, so ‘we need to be prepared ‘, she said.

That implies the need for ‘a clear consensus – agreed within the Governing Council and understood by the public – on what tools are available to us when inflation is too low, and how they should be systematically deployed in response to different types of shock.’

Lagarde did not address the ECB’s current policy stance directly other than to note in passing that both fiscal and monetary policy ‘must remain expansionary for as long as necessary to achieve their respective goals.’