ECB’s Historic Shift in Inflation Targeting

Europe has been the epicenter of economic disruption for the past few years. Since Brexit made its way into mainstream debate, the Eurozone has been under constant stress regarding the future of a shared economy. However, the pandemic has redefined the perils of economic disparity. As if shedding a spotlight on the inadequacies of European monetary policies.

The European Central Bank (ECB) recently unveiled a new strategy that would provide a supposedly perfect underpinning groundwork to pump more stimulus in the struggling European economies. The announcement came about as ECB finally abandoned its years-long policy of vague inflation targetting. The rescinded policy failed to objectify the inflation target by presenting an obscure goal of achieving inflation ‘below but close to 2%’. The ECB instead shifted to a dovish outlook to stimulate the European economy that has been inert for the past few years. Putting on a practical lens, the ECB President Christine Lagarde cleared out the directional shift in ECB’s policy to let the economy breathe: “The new formulation removes any possible ambiguity and resolutely conveys that 2% [Inflation] is not a ceiling”. The ECB’s announcement proves that Europe’s economic policy is taking a historic shift towards a dovish mindset and letting the economy spread its wings as the global markets rebound from the pits of havoc razed by the pandemic.

The ECB, however, is not the first central bank to incline away from a hawkish agenda. Europe’s stride towards an expansionary measure comes months after the Federal Reserve’s flexible inflation targetting strategy was established in August 2020. The Fed’s strategy allowed the economy to bloom past the concrete 2% level of inflation, subjecting the boom as compensation for an inadequate economic performance last year. Similarly, the strategy adopted by the ECB not only allows the investors much harkened clarity on the ECB’s outlook on controlled growth and inflation targetting but also allows the markets to overshoot beyond tight barriers to compensate for the underperformance that ensued after the outbreak of the virus.

Simply put, the ECB has made it abundantly clear that it would allow ample room for the economy to recover and prosper. Asserting that 2% is not a definitive ceiling assures the rebounding markets that the ECB would not undertake a hawkish monetary policy and hike the interest rates even if the inflation surpasses the 2% mark. However, unlike the United States where transitionary inflation clocked a colossal 5.4% inflation in June alone, the European economy paints a contrasting picture. The ECB’s projections highlight the inherent problem of static growth in the Eurozone: Europe’s average inflation dragging with predictions marking at 1.3% in 2022. Coupled with a strengthening Euro in the Forex market, growth is only being hampered as the net effect weights heavily on the current account. Therefore, while the ECB is joining the mainstream inflation targetting, Europe’s inherent growth seems highly unlikely to hit the target of 2%, to begin with: let alone surpass it.

Taking all the elements into perspective, it is apparent that the ECB should be prepared to pump more stimulus into the economy as staggering demand and low price pressures might pull the market into another recession. The prospect seemed improbable for years. However, the pandemic turned the farfetched scenario into an approaching reality. Germany, Europe’s largest economy, plummeted during the intense battering of the pandemic last year. Data reveals that Germany’s inflation rate fell below 0% as consumption slumped while recently adopted tax cuts further deteriorated the national exchequer. According to leading economists, the Eurozone is very likely to slip further into deflation as the Delta variant sparks all the same fears and restrictions worldwide. All the scenarios, thus, make a viable case for the ECB to turn more tolerant and conducive towards a liberal inflation targeting, at least in the short run.

The ECB is all set to boost its stimulus by the end of 2021 as it has already pledged to buy 1.35 trillion – equivalent to $1.6 trillion – worth of government bonds under the pandemic emergency program. Yet, unlike the US Fed that is all set to pull the rug from its Asset Purchase Program, the ECB is touted to pour more stimulus to facilitate the faltering economies. However, with trillions of Euros already spend in monetary stimulus and negative interest rates sustained to speed up the European economy, the ECB has still struggled to boost inflation. Now with the virus reemerging and inflation at a standstill even in the forecasts, the ECB’s highly dovish strategies make the economic trends all the more complex to predict and maneuver.

Syed Zain Abbas Rizvi
Syed Zain Abbas Rizvi
The author is a political and economic analyst. He focuses on geopolitical policymaking and international affairs. Syed has written extensively on fintech economy, foreign policy, and economic decision making of the Indo-Pacific and Asian region.