What to expect from the ECB’s monetary policy strategy review?

Emphasis will be placed on greening monetary policy and clarifying the ECB's price stability objective, but is this enough?

By: Date: June 23, 2021 Topic: Macroeconomic policy

This piece was originally published in the Money Review section of Kathimerini and El Economista.

The COVID-19 pandemic forced the European Central Bank (ECB) to postpone the review of its monetary policy strategy, or how it goes about ensuring price stability in the euro area. Although measures to contain the pandemic’s economic fallout will continue to be in place for some time, the ECB is now expected to finalise its monetary policy strategy review by the end of the year, if not earlier, compared to the original aim of end-2020.

What changes can we expect the review to trigger – and what will not change?

The one change we are sure to see is the emphasis that will be given to greening monetary policy. The ECB has already moved in this direction even though central banks are not necessarily the policy institutions best placed to deal with climate change. There is now broad agreement that all need to do their part to meet climate targets, and that includes central banks. ECB president Christine Lagarde has been clear and very consistent about this point, right from the start of her mandate.

The second change we can expect is the clarification of the ECB’s price-stability objective. Price stability is expected to be redefined from an inflation rate of “below but close to 2%”, to inflation of 2%. But this is the easy part, and is the least the central bank can do to enable the inflation target to be a focal point for expectations. Given how important expectations are in affecting inflation, it is surprising this has not already happened. In fact, why was price stability even defined the way it was?

But is this enough? Inflation is rarely exactly at 2%. Does this then mean that such a precise objective, and therefore also price stability, is seldom, if ever, to be achieved? Isn’t that potentially counterproductive?

The US central bank, the Federal Reserve, has addressed this in its own strategy review by saying that inflation should be at 2% “on average”. Inflation can be above 2%, provided it also drops below it, so that “on average” it lands on the target.

While this definition is easy to justify at any point in time looking back, it is not easy to use to predict the future. If inflation has been below 2% for a year, say, is it reasonable to assume that the central bank will aim to be above 2% in the coming year? Or should the reference point be longer than just one year? Also, the longer inflation has been on one side of its target, like what we experience today with low inflation, the more difficult it is to revert and sustain it on the other side for however long is needed, so that “on average” it is exactly at 2%.

In theory, price stability defined as inflation equal to 2% on average is reasonable. But in practice, if the definition stops here, it does not provide a useful signal that can help economic agents form expectations. But what would provide a helpful signal?

There are two options here.

The definition of price stability needs to include also an explicit commitment to a policy horizon, average over, say, 2 years, or the business cycle. But central banks are understandably very reluctant to do that, given the low and declining interest rate environment of the past ten to fifteen years. At the very least, this means that our understanding of how monetary policy transmits to the economy is imperfect.

The second option is to have tolerance bands around the numerical target. The central bank would aim for 2% but tolerate inflation within a certain range around it. For as long as inflation is within the tolerance band, then it is also at 2% on average. But now the time horizon does not need to be explicitly identified.

In fact, the majority of central banks that carry out inflation targeting have these tolerance bands as an integral part of their policy and as a communication strategy. Markets will themselves have views on policy reversals as inflation approaches either edge of the bands. The exact width of this band is debatable, but given that we operate in a very uncertain environment, the central bank should err on the side of wider bands, say between 0.5% and 3.5%.

But perhaps the most important feature of a tolerance band is that it provides a very clear framework for evaluating central bank performance. A strategy that is transparent on what is successful and what is not is beneficial to the central bank, its objectives and ultimately society.

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read about event More on this topic

Upcoming Event


European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Grégory Claeys and Wolfgang Lemke Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author

Blog Post

European governance

Pandemic prevention: avoiding another cycle of ‘panic and neglect’

Agreement is needed at international level on mechanisms to ensure better preparedness for the next pandemic.

By: Anne Bucher Topic: European governance, Global economy and trade Date: October 7, 2021
Read article More on this topic More by this author


Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More on this topic More by this author


What Evergrande signals about China's economic future

Under Xi Jinping's new economic agenda 'common prosperity', China is cracking down on indebted real estate developers like Evergrande.

By: Alicia García-Herrero Topic: Global economy and trade Date: September 30, 2021
Read article More on this topic More by this author

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Read article More on this topic More by this author


The pandemic’s uncertain impact on productivity

The pandemic has certainly permanently affected our way of working. Whether this is for the better remains to be seen.

By: Maria Demertzis Topic: Macroeconomic policy Date: September 28, 2021
Read about event More on this topic

Past Event

Past Event

Monetary and macroeconomic policies at the crossroads

Bruegel Annual Meetings, Day 2- In this session we would like to discuss monetary and macroeconomic policies after Covid-19.

Speakers: Grégory Claeys, Per Callesen, Gita Gopinath, Jorge Sicilia Serrano and Lawrence H. Summers Topic: Banking and capital markets Location: PALAIS DES ACADEMIES, RUE DUCALE 1 Date: September 2, 2021
Read article Download PDF

External Publication

Building the Road to Greener Pastures

How the G20 can support the recovery with sustainable local infrastructure investment.

By: Mia Hoffmann, Ben McWilliams and Niclas Poitiers Topic: Global economy and trade, Testimonies Date: July 15, 2021
Read about event

Past Event

Past Event

Financing for Pandemic Preparedness and Response

How can we better prepare for future pandemics? In this event, co-hosted by the Center for Global Development and Bruegel think tanks, speakers will present "A Global Deal for Our Pandemic Age", a report of the G20 High Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response.

Speakers: Masood Ahmed, Victor J. Dzau, Amanda Glassman and Lawrence H. Summers Topic: Banking and capital markets, Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 14, 2021
Read article More on this topic

Blog Post

Fair vaccine access is a goal Europe cannot afford to miss – July update

European countries must do more to tackle the vaccine uptake gap. Vaccination data should be published at the maximum granularity level so researchers and local decision-makers can monitor progress.

By: Lionel Guetta-Jeanrenaud and Mario Mariniello Topic: Macroeconomic policy Date: July 14, 2021
Read article More on this topic

External Publication

A Global Deal for Our Pandemic Age

Report of the G20 High Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response.

By: Tharman Shanmugaratnam, Lawrence H. Summers, Ngozi Okonjo-Iweala, Ana Botin, Mohamed El-Erian, Jacob Frenkel, Rebeca Grynspan, Naoko Ishii, Michael Kremer, Kiran Mazumdar-Shaw, Luis Alberto Moreno, Lucrezia Reichlin, John-Arne Røttingen, Vera Songwe, Mark Suzman, Tidjane Thiam, Jean-Claude Trichet, Ngaire Woods, ZHU Min, Masood Ahmed, Guntram B. Wolff, Victor J. Dzau and Jeremy Farrar Topic: Global economy and trade Date: July 9, 2021
Load more posts