Three changes in (official) ECB thinking
As an addendum to this David Ruccio post about changes in thinking at central banks:
At least three mayor recent changes in official ECB statements can be witnessed:
1. The idea that keeping inflation low and stable is the best and only contribution the ECB can make to financial stability has become obsolete. At this moment, ‘financial stability’ even is the ‘second mandate’ of the bank and Draghi explicitly admits the possibility of a ‘bad equilibrium’ (governments have to pay high interest rates because they can’t pay their debts because they have to pay high interest rates). The role played by banks, irresponsible lending and the socialization of bank debts by irresponsible governments in bringing about bad equilibrium is acknowledged. ‘Financial stability’ is no longer equated with ‘low and stable inflation’.
2. Though the bank is officially still targeting money growth, board members like Joerg Asmussen frankly state that it’s targeting the interest rate instead.
3. The ECB now acknowledges that national differences as well as interactions and flows of capital between Eurozone nations do matter. It’s not just targeting Eurozone wide averages of the interest rate anymore.
These three changes are the intellectual foundation for its plan to buy bonds: the bank is not just responsible for the average interest rate but also for national rates, at least to the extent that large interest rate differences between countries make it more difficult for the bank to target the average rate. Also, high government bond rates may indirectly hamper cheap borrowing by companies and households in high rate countries, while these bond rates also may be too high (or low!) considering the economic ‘fundamentals’, because of a ‘bad equilibrium’.
More changes are needed.
First, the bank will have to start to target a broader metric of inflation like the GDP-deflator instead of the consumer price index.
Second, next to this it has to start to officially monitor asset price inflation, i.e. national house prices.
Third, to do this it will have to keep track of the monetary aggregates, but this time not the amount of ‘broad money’ (M-3), which it can’t control anyway, but one of its ‘counterparts’, money creation caused by ‘lending for house purchase’. This kind of lending has (according to the ECB statistics) often been the most important cause of the increase of the amount of money in the Eurozone and surely in some of the troubled nations, were out of control ‘lending for house purchase’ was one of the main causes of the housing bubbles. Though the ECB should monitor this, it is clear that national (tax-)policies are more important to keep irresponsible lending/borrowing in check than Eurozone-wide interest rates.
The question if the ECB should also become responsible for low unemployment, like the Fed, is very important. But considering the design of the Eurozone it’s indeed not up to the ECB to answer this question. The changes mentioned above are however completely within its mandate.