ECB Insight: Renewed Dissatisfaction with ECB’s Staff Projections Increasingly Evident

24 March 2022

By David Barwick – FRANKFURT (Econostream) – The sore subject of the trustworthiness of the European Central Bank’s staff macroeconomic forecasts is flaring up again following the publication of projections two weeks ago implying that medium-term euro area HICP would be so obliging as to emerge from the current extreme turbulence at levels conveniently consistent with the ECB’s 2% price stability target.

Notwithstanding the negative implications of war’s outbreak for basic raw materials and supply chains; the associated waves of sanctions and countermeasures; the increasing awareness that the energy transition will add to price pressures; the recognized imperative of accelerating that transition; the fact that the ECB’s models have consistently underestimated actual developments; generally tight labour markets; and expectations deemed to be on the move (depending on to whom one speaks), the ECB on March 10 unveiled updated projections showing that Eurozone inflation would rocket to 5.1% in 2022 from December’s estimate of 3.2% but then subside with an ethereal grace to 2.1% in 2023 and 1.9% in 2024, meaning hardly a budge from the previous forecast of 1.8% for both years.

‘I can’t buy the figure for 2024, because it’s so far off and there are so many uncertainties and unexpected developments, not only in the economy but also the world’, a member of the Governing Council told Econostream the day after the new forecasts were released.

‘1.9% [HICP] in 2024 - I mean, it’s almost the same as we projected for this year last September’, he said. Indeed, last September – aeons ago, under the circumstances – the ECB envisioned 2022 euro area HICP of 1.7%, subsequently revised to 3.2% and more recently to 5.1%.

While they may be franker speaking on background, a few ECB insiders have also signalled their scepticism openly, which can probably be understood to be the tip of the iceberg.

For example, Austrian National Bank Governor Robert Holzmann on Tuesday said, ‘This 1.9% [2024 HICP ECB staff forecast] is part of a mechanism for the decisions of the ECB. If certain conditions are met, then we can act.’

That, it must be said, gently suggests that the 1.9% does not exclusively serve the purpose of reflecting the ECB’s macroeconomic expectations with unflinching honesty. Rather, to the extent judgment plays a role in the outcome of the projection exercise, a result can be produced that justifies certain decisions and actions – or not.

‘For me that [1.9%] is the most optimistic scenario that one can imagine’, Holzmann continued. ‘It is not inconceivable, but not very probable. Personally, I believe that inflation in the coming years will be higher. It will go back down, but it will be higher than this 1.9%.’

It is also worth noting that Holzmann was speaking in a podcast produced by his own institution, meaning that it wasn’t just the answer that was up to him, but the question as well. In other words, he expressly wanted to dissent.

He is not alone. In a speech on Monday, German Bundesbank President Joachim Nagel noted that ‘[i]t is true that the ECB staff projections show declining inflation rates in the euro area over the next two years, moving towards our 2% target.’

He swiftly continued: ‘But the uncertainty in the price outlook is extremely high. And it has increased significantly due to the war in Ukraine.’

Coming from a central banker who still attaches high importance to being a team player, the message that the ECB’s own projections are subject to considerable doubt is clear.

But then, even ECB Vice President Luis de Guindos was hard-pressed to defend the revised forecasts. Asked last week by German business daily Handelsblatt why such a pronounced retreat of inflation would ‘happen so fast’, de Guindos’ answer seemed a plea for absolution paired with wishful thinking.

‘At the moment making projections is particularly difficult’, he said. ‘One reason for the drop in inflation could be that the significant increase in energy prices cannot last for too long. Prices can stabilise at a high level, but no longer increase at the current high rate.’

Challenged in the context of the ECB’s own spotty track record, de Guindos lamented again that forecasting was a tough job and made reference to the problem of mean reversion that has plagued the ECB lately.

In any case, he added that ‘[i]f we continue to underestimate inflation, we will respond.’ That is, he almost seemed to be arguing, in the end it doesn’t matter if we’re wrong, as we’ll right it if so.

Finding a Governing Council member willing to explicitly stick up for the 2024 HICP forecast is less easy. Most just cite – which is not to say ‘parrot’ – the updated numbers, which central bankers have always had somewhat of a tendency to regard as gospel, at least publicly.

Perhaps Banca d’Italia Governor Ignazio Visco came closest to mounting a defence when he one week ago claimed that ‘there is certainly good reason to believe that, given wage prospects and the state of expectations, headline inflation will progressively converge to 2% as the serious disturbances generated by the dramatic evolution of the Russia-Ukraine war fade away.’

But then, Visco is known least of all for highlighting reasons to withdraw accommodation, and arguably, his home country of Italy is the main reason why the ECB is not too keen on peddling anything but the idea of limited need to tighten the monetary screws.

Naturally, an optimal macroeconomic outcome cannot be excluded. But in stubbornly viewing the range of possibilities through rose-coloured glasses, the ECB is in the process – yet again – of undermining its own credibility with an approach to forecasting in which it periodically and reluctantly cedes just enough ground to reality to avoid becoming too vulnerable to accusations of propagating fiction.

In the meanwhile, we expect the chorus of doubts so far expressed relatively gently by Holzmann and Nagel to strengthen.