Download publication

Policy Contribution

A monetary policy framework for the European Central Bank to deal with uncertainty

In this Policy Contribution prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue, the authors review the emerging challenges to central banks, and propose an updated definition of price stability and an adequately refined monetary policy framework.

By: , , and Date: November 22, 2018 Topic: European Parliament

This Policy Contribution was prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue of 26 November 2018 between ECON and the President of the European Central Bank. The original paper is available on the European Parliament’s webpage (here). Copyright remains with the European Parliament at all times.

Central banks face new challenges. First, the potential long-term decline in neutral rates of interest in advanced economies could reduce the space for central banks to make policy-rate cuts.

Second, the potential flattening of the Phillips curve (i.e. the weakening of the relationship between inflation and unemployment) in recent decades could reduce the ability of central banks to reach their inflation targets.
Third, the discussion on whether central banks should also target financial stability has re-emerged as a result of the crisis.

Fourth, the euro-area architectural framework remains incomplete. The problematic interaction between nineteen different fiscal policies and a common monetary policy, the lack of a stabilisation tool and differences in national macro-prudential frameworks would all suggest significant reforms are needed in these realms to strengthen the overall resilience of the system. However, the probability of seeing material changes before the next recession is relatively low, thus presumably leaving the European Central Bank’s pivotal role unchanged.

More generally, fundamental uncertainty surrounding concepts at the core of the economy, and therefore demand management, has emerged. Monetary policy has to navigate without full knowledge of what the post-crisis ‘new normal’ is going to be.

In light of these considerations, we recommend that the ECB should update its definition of price stability to target core inflation around two percent per year (allowing a tolerance band on either side of the two percent target), on average, over a longer time horizon.

Compared to other proposals (such as increasing the targeted inflation level or price-level targeting), our recommendation has the advantage of not departing drastically from the current inflation target and is therefore easier to communicate.

In our view, monetary policy should not target financial stability. Other more targeted (and country-specific) tools should be deployed to avoid the build-up of financial stability risks. Closer coordination with national macroprudential authorities and greater harmonisation in the use of macroprudential policies are however strongly recommended, as it is now acknowledged that financial and monetary policies are closely interlinked.

Read article More on this topic More by this author
 

Blog Post

The implications for public debt of high inflation and monetary tightening

Expected increases in interest rates and reductions in real GDP growth rates will result in relatively small increases in public debt-to-GDP ratios, but inflation will reduce debt ratios very substantially

By: Zsolt Darvas Topic: Macroeconomic policy Date: June 29, 2022
Read article More on this topic
 

Blog Post

A new European tool to deal with unjustified rising spreads

The European Central Bank needs a new tool to prevent the current rise in spreads, triggered by monetary policy tightening, from escalating into a new euro-area crisis.

By: Grégory Claeys and Maria Demertzis Topic: Banking and capital markets Date: June 20, 2022
Read article Download PDF
 

External Publication

European governanceEuropean Parliament

Fragmentation risk in the euro area: no easy way out for the European Central Bank

The ECB should design a specific tool that will accompany interest rate hikes to neutralise the risk of fragmentation directly for countries facing it, staying within the bounds of the EU treaties and ensuring political legitimacy. We also advocate structural changes to the ECB’s collateral framework to avoid unnecessary uncertainty surrounding the safe asset status of European sovereign bonds.

By: Maria Demertzis, Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: European governance, European Parliament, Testimonies Date: June 8, 2022
Read article More by this author
 

Opinion

European governance

Three headaches for the European Central Bank

Even though inflation in the euro area is lower than in the US, three issues make it a lot more difficult for the ECB to control inflation and preserve financial stability. Once again, the limits of EMU architecture are visible and will require a rethink.

By: Maria Demertzis Topic: European governance, Macroeconomic policy Date: May 31, 2022
Read article More on this topic More by this author
 

Podcast

Podcast

Taming inflation?

What are the implications of prolonged inflation?

By: The Sound of Economics Topic: Macroeconomic policy Date: May 25, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read about event More on this topic
 

Past Event

Past Event

What is in store for Euro area economies?

ECB Executive Board Member Philip Lane discusses the outlook for Euro area economies.

Speakers: Maria Demertzis and Philip Lane Topic: European governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 5, 2022
Read about event More on this topic
 

Past Event

Past Event

Tackling future risks to banks

How to address vulnerabilities in banks in the coming years?

Speakers: Maria Demertzis and Elizabeth McCaul Topic: Banking and capital markets Date: March 29, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Podcast

Podcast

War in Ukraine: implications for the global financial system and central banks

A special episode of the Sound of Economics Live on the global financial system and central banks in the wake of sanctions imposed on Russia.

By: The Sound of Economics Topic: Banking and capital markets Date: March 2, 2022
Read about event More on this topic
 

Past Event

Past Event

War in Ukraine: implications for the global financial system and central banks

A special episode of the Sound of Economics Live on the global financial system and central banks in the wake of sanctions imposed on Russia.

Speakers: Silvia Merler, Giuseppe Porcaro and Nicolas Véron Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 2, 2022
Load more posts