ECB’s Rehn: Our Ambiguous Inflation Target Gets in the Way of Our Monetary Policy

26 March, 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank currently formulates its inflation target in a manner that diminishes the effectiveness of its monetary policy, ECB Governing Council member Olli Rehn said on Friday.

In an opinion piece in Politico, Rehn, who heads the Bank of Finland, noted that the U.S. Federal Reserve had determined that lower unemployment did not necessarily stoke inflation and had adopted a regime of average inflation targeting that would compensate temporarily for past undershooting. This framework ‘seems to have gained credibility’, based on longer-term inflation expectations, he said.

‘The European and U.S. economies are not that different when it comes to assessing the slack in the economy or the level of employment, so the Fed’s findings could serve as a relevant benchmark for the ECB’s own strategy review, which will be completed later this year’, he said.

The ‘below but close to 2%’ formulation of the ECB’s inflation target may have been appropriate in the early 2000s, he wrote, but appears asymmetric and ambiguous. ‘In our current environment of chronically low inflation, this ambiguity is hampering the effectiveness of our monetary policy', he said.

Rehn said it was ‘critical’ that the ECB’s inflation target be seen as symmetric by the public and that it thus be ‘a genuine price stability target at — and not below — 2%.’ The ECB’s reaction function should respond forcefully and via ‘equally effective policy actions’ to any deviation from the objective.

‘This would take the increased risk of hitting zero interest rates into account’, he said.

‘As we prepare for our prospective exit from pandemic policy measures, we can capitalize on the strategy review and forward guidance to lift inflation expectations, support economic growth and employment, and help achieve the inflation target in the Eurozone in the coming years’, he said.