ECB’s Panetta: HICP Has Been Below 2% So Long That We Need HICP Above 2%

29 July 2021

By David Barwick – FRANKFURT (Econostream) – A record of euro area inflation below the European Central Bank’s target implies a need to overshoot that target now, ECB Executive Board member Fabio Panetta said Thursday.

Speaking in an interview with Italian daily Corriere della Sera, a text of which was made available by the ECB, Panetta said, ‘Because inflation has been below 2% for so long, we need values of above 2% to pursue our target symmetrically.’

Various ECB Governing Council members have promised that Europe’s monetary policymakers ‘do not target inflation at above 2% to compensate for past shortfalls’, as Mārtiņš Kazāks, Governor of Latvijas Banka, expressed it to Econostream this week in an interview.

According to Panetta, the ECB’s revised strategy would address the problem that the previous price stability definition ‘led people to believe that the ECB wanted to stay well below 2%’. Panetta did not say what ‘well below 2%’ for him meant, but ECB President Christine Lagarde earlier this month suggested that the former wording had generated the perception that the ECB was aiming for ‘between what some see as 1.7, others as 1.95.’

The chief implication of the new strategy, Panetta continued, is that ‘from now on when inflation falls below 2% our monetary policy should take inspiration from “Pirates of the Caribbean”, even if some would prefer “Sleeping Beauty”.’

In the future, even as inflation nears 2%, the ECB will be content to observe first, he said, and ‘only raise rates when we’re convinced that inflation can be firmly anchored at 2% in the medium term according to a series of parameters which are clearly set out in the new forward guidance, for both expected and actual inflation.’

The ECB’s past impatience had led it to hike rates too soon, resulting in ‘excessive downward pressure on inflation’, he said. However, ensuring price stability may imply a need to ‘run the economy hot’, he said.

Such an approach was not only not risky, but indeed ‘a prerequisite for making full use of the labour resources available and for generating upward pressure on wages that will push inflation up to levels in line with our target’, he reassured.

For now, he made clear, inflation was only under temporary upward pressure.

Although asset purchase programmes had yet to be discussed within the Governing Council, the expansionary nature of forward guidance would be at odds with a restrictive approach toward the ECB’s other most important tool at the moment, namely asset purchases, he said.

‘The main issue for me is how to use asset purchases effectively to consolidate the forward guidance, in particular to ensure an even transmission of monetary policy throughout the euro area’, he said.

Without being a response specifically to the Delta variant, the new guidance ‘indicates how we will react if the Delta variant delays the return of inflation to 2%’, he said. While unwilling to exclude the idea that the variant would thwart economic recovery, Panetta suggested that its impact would be weaker than previous waves of the pandemic.

Panetta said he did not see why Europe could not follow the example of the US and ‘recover the GDP lost along the way and the productive capacity and jobs destroyed by the crisis as quickly as possible’.

‘To do this, fiscal policy and monetary policy must continue to support the economy’, he said. To do otherwise, he suggested, would run the ‘still high’ risk of an ‘incomplete’ recovery. At the same time, the downside of ongoing support was limited, he said, given that ‘the risks of the economy overheating and high inflation are still contained.’

Panetta made no secret of his preferred source of the fiscal part of the expected support: ‘Europe has new common measures, such as NextGenerationEU … and we can be ambitious’, he said. Neither did he conceal his hopes for what growth thus funded would accomplish: ‘Only a sustained pace of growth will solve the problems of employment and debt.’

The seasonally adjusted unemployment rate in Italy in May stood at 10.5%, well above the euro area average of 7.9% and above all other member states except for Greece and Spain. General government gross debt in Italy in the first quarter of 2021 was equal to 160.0% of GDP, far more than the euro area average of 100.5% and second only to Greece.

‘European funds must be used – particularly by countries benefiting most, like Italy and Spain – to modernise the economy and to trigger a growth phase that everyone can take advantage of’, he said.

This would be to the advantage of even the economically soundest member states, he insisted, calling it ‘in the interests of all countries – including those with the strongest economies – to benefit from widespread growth’ and invoking a straw man argument: ‘Anyone who thinks they can grow on their own would be behaving like Baron Munchausen, who wanted to lift himself off the ground by pulling himself up by his hair.’

As for the Italian contribution in the form of domestic structural reform – ‘much talked about but seldom seen’ in the past, he conceded – ‘now the situation is different’, he said, the reason being that this time around, ‘we aren’t planning reforms during a recession or in the midst of political and social tensions caused by austerity.’