Policy brief

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 Dialo

Publishing date
22 November 2018

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.

About the authors

  • Grégory Claeys

    Grégory Claeys, a French and Spanish citizen, joined Bruegel as a research fellow in February 2014, before being appointed senior fellow in April 2020.

    Grégory’s research interests include international macroeconomics and finance, central banking and European governance. From 2006 to 2009 Grégory worked as a macroeconomist in the Economic Research Department of the French bank Crédit Agricole. Prior to joining Bruegel he also conducted research in several capacities, including as a visiting researcher in the Financial Research Department of the Central Bank of Chile in Santiago, and in the Economic Department of the French Embassy in Chicago. Grégory is also an Associate Professor at the Conservatoire National des Arts et Métiers in Paris where he is teaching macroeconomics in the Master of Finance. He previously taught undergraduate macroeconomics at Sciences Po in Paris.

    He holds a PhD in Economics from the European University Institute (Florence), an MSc in economics from Paris X University and an MSc in management from HEC (Paris).

    Grégory is fluent in English, French and Spanish.

     

  • Maria Demertzis

    Maria Demertzis is the interim Director at Bruegel. She has previously worked at the European Commission and the research department of the Dutch Central Bank. She has also held academic positions at the Harvard Kennedy School of Government in the USA and the University of Strathclyde in the UK, from where she holds a PhD in economics. She has published extensively in international academic journals and contributed regular policy inputs to both the European Commission's and the Dutch Central Bank's policy outlets.

  • Jan Mazza

    Jan, an Italian and Polish citizen, is a research assistant at Bruegel. He holds a Bachelor's degree in Economics and Political Science and a Master's degree in Economics, both from the University of Bologna, and a Master of Science in Economics and Philosophy from the London School of Economics. During his studies, he also spent a semester at the University Paris-2 Panthéon-Assas and one at the Ludwig-Maximilians University of Munich.

    Before joining Bruegel he was a trainee at the European Commission (DG Budget) and at the Brussels office of Assonime, the association of Italian joint stock companies.

    His research interests include European governance, international economics, monetary and fiscal policy.
    Jan is fluent in Italian, English and French and has a good knowledge of Spanish.

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