Evan Soltas
Apr 20, 2013

Calling on the ECB to Act

I did a series of three posts making the case for the European Central Bank to ease monetary policy. I figured I would post them all together on my personal blog rather than separately.

An excerpt from the first (read in full here):

And then there was one.

The European Central Bank is the last major central bank without an aggressive monetary easing program. The last few years of stuttering economic recovery have forced its counterparts -- the Bank of Japan, the Federal Reserve and the Bank of England -- one by one into action.

Consider all that’s happened over the last few months alone. Japan’s central bank lifted its inflation target to 2 percent and launched a massive bond-buying plan of 7.5 trillion yen per month. The U.K. Treasury tweaked the Bank of England's remit to confirm that temporary overshoots of its inflation target were permissible. (Its incoming governor Mark Carney seems likely to push for a commitment to an extended period of low interest rates.) And the Fed has been buying Treasuries at $85 billion per month since December.

And the ECB? It left interest rates unchanged at its most recent policy meeting, signaling that it might cut them later only if things get even worse. It let the monetary base, or the quantity of currency and reserves held at the central bank, shrink by some 60 billion euro last month. Yet, more than any other big economy, the euro area badly needs new monetary stimulus.

Europe’s troubles are often framed as a sovereign-debt crisis. But Europe's unemployment rate of 12 percent and rising is happening not because of government debt but because of bad macroeconomic policy. Europe has suffered from a nominal shock -- that is, a drop in aggregate demand. Extraordinarily weak nominal growth now prevents the reset of prices and wages to levels that would support higher output and employment.

An excerpt from the second (read in full here):
As Europe's economy began to turn for the worse in November 2010, Jürgen Stark, an austerity-minded economist then on the European Central Bank's executive board, said, "The mandate of the ECB to deliver price stability is clear and will remain unchanged. It is anchored in the Maastricht Treaty. I am glad that we have this single mandate instead of a dual mandate or even more objectives."

Stark was wrong -- and not just in calling for the ECB to stop its emergency monetary measures. The ECB doesn't have a single mandate. That term appears in none of the treaties establishing the central bank. The treaties speak instead of its "primary objective" of price stability.

A single mandate would mean the ECB had no other goal, which is what Stark was proposing. Yet the very notion of a "primary objective" implies other, admittedly subsidiary, objectives -- and the ECB's founding documents say what these are. Without prejudice to the objective of price stability, the European System of Central Banks "shall support the general economic policies in the Union," according to Europe's rulebook. "These include inter alia 'full employment' and 'balanced economic growth.'"

The ECB explains its understanding of this mandate on its website. "Given that monetary policy can affect real activity in the shorter term," it writes, "the ECB typically should avoid generating excessive fluctuations in output and employment if this is in line with the pursuit of its primary objective."

Article 66 also empowers the ECB to act if movements of capital "cause, or threaten to cause, serious difficulties for the operation of economic and monetary union."

An excerpt from the third (read in full here):
According to its own reasoning, the European Central Bank has set its inflation target too low.

Since 2003, the ECB has promised that inflation, as measured by the euro area's Harmonized Index of Consumer Prices, would average 2 percent or below over the medium term. But 2 percent is no longer enough.

The 2 percent target, the ECB says on its website, was chosen to "provide an adequate margin to avoid the risks of deflation" and to "provide a sufficient margin to address the implications of inflation differentials in the euro area. It avoids that individual countries in the euro area have to structurally live with too low inflation rates or even deflation." That reasoning made sense in 2003. The same logic today would recommend a much higher inflation target for the euro area, perhaps of 3 or even 4 percent per year.