The European Central Bank has adopted a new approach to managing the economy that would tolerate transitory periods of consumer inflation moderately above its 2% goal — and take greater account of climate change in its forecasting and stimulus programs.
The changes announced Thursday for the 19 countries that use the euro are the first review of the bank’s overall strategy since 2003 and follows years in which inflation ran below the bank’s goal for extended periods of time.
A key aspect is replacing the bank’s previous inflation goal of “below but close to” 2% annual inflation. The new target is described as 2%, but “symmetric.” That means it would allow a “transitory period” of above-target inflation. In theory, that would allow the bank to maintain low interest rates and stimulus programs such as bond purchases with newly created money for a longer period of time.
ECB President Christine Lagarde said that the new goal would give the bank more room to take “especially forceful and persistent action” in the event of an unexpected economic crisis. Such room to maneuver is especially important when market rates are close to zero, as they are now in many instances. That means the economy could more easily slip into deflation, a crippling downward spiral of prices and falling investment, without decisive central bank intervention.
The decision moves the ECB in the same direction as the U.S. Federal Reserve, which moved to average inflation targeting last year that could allow inflation moderately above 2% for some time. The ECB goal is not as aggressive as the Fed’s, since it would “not actively aim to run inflation above target to make up for previous shortfall,” said Andrew Kenningham, chief Europe economist at Capital Economics.
“It would have no immediate implications for monetary policy, but in the longer run may imply policy would be looser for longer,” Kenningham said in an emailed research note.
In another change, Lagarde said public dialog with citizens had convinced the bank to start counting the rise in house prices in its inflation measures to better represent consumer prices as they are relevant to households. Including owner-occupied housing in the EU’s inflation index would take years, however; therefore the bank said it plans to use initial estimates of housing costs to supplement its inflation measures.
The bank said it would do more to take the impact of climate change into its monetary policy, saying that global warming could have “profound implications” for price stability. It said it would expand its economic models and statistics to better assess the effect that climate change could have on the economy.
When purchasing bonds, the bank said it could take into consideration whether the companies issuing those bonds were compliant with EU legislation implementing the 2015 Paris climate change accords. Buying corporate and government bonds is a tool the bank uses to drive down borrowing costs for businesses, households and government budgets.
The bank’s mandate established in the basic European Union treaty is to pursue price stability. Once that is achieved, it can pursue other goals consistent with the EU’s economic policies.
The bank said it would apply the new strategy starting with its next meeting on July 22.