Or rather, why isn’t it doing something? Consumer price inflation is currently 1.7%. The OECD expects 1.6% as a whole for 2013, and 1.2% for 2014. The ECB sees downside risks due to the impact from lower activity, which it acknowledges is falling but which it hopes will recover soon. The OECD expects GDP to be flat this year, and increase by 1.3% next - is that what is meant by a recovery? On activity the ECB sees downside risks, but does not mention any upside risks. On the prices side they see upside risks from administered prices, VAT and oil, but for all three it is questionable whether it should react to these type of shocks at all.
In fact, if you look at other measures of inflation, the inactivity is even more puzzling. Annual increases in the GDP deflator have been at or below 1.2% since 2009, and the OECD expect a rise of only 1% in 2014. Wage increases (compensation per employee) have been below 2% since 2009, and are expected by the OECD to be around 1.5% this year and next. (Wages should normally increase by more than price inflation because of underlying productivity growth.)
With this in mind I read Draghi’s statement today, where he announced no change in the 0.75% interest rate, looking for some justification for why nothing was being done despite falling activity and below target inflation. After listing all the reasons that would normally suggest cutting interest rates, there was this: “Against this overall background our monetary policy stance will remain accommodative for as long as needed.”
I’m sorry, but this does not compute. The Eurozone is suffering from a large negative demand shock due to many things: partly austerity, but also the kind of balance sheet adjustment that we have seen elsewhere. (See, for example, Reza Moghadam of the IMF here.) In macroeconomic terms, we have a large leftward shift in the IS curve. What monetary policy is meant to do in these circumstances is to cut real interest rates to restore demand. In macroeconomics speak, to move down the IS curve until demand is restored. Moving a bit along the IS curve, and saying ‘look, we are helping’, is not good enough. Policy needs to respond to the size of the shock. Now monetary policy is difficult when signals and forecasts conflict. But when everything is pointing in the same direction, it is really easy.
The other interpretation of what the ECB is doing is that they do understand basic macroeconomics, but consumer price inflation of 1.7% prompts no action (because its close to 2%), and they expect (in contrast to the OECD) inflation to stay at this level. But is this plausible? One word that does not feature in Draghi’s statement is unemployment. The OECD expects unemployment to rise to 12% this year and next, which is 2% higher than in any year from 2000 to 2010. So how does this square with consumer price inflation stabilising at just below 2%? The answer is it does not. The ECB staff forecasts for consumer price inflation for 2014 are “between 0.6% and 2.0%” - exactly in line with the OECD.
So something is very wrong here. Even if you assume that the ECB are focused on hitting consumer price inflation alone, and care nothing for activity, unemployment or other inflation measures, they are doing nothing about future inflation falling well below 2%. So however you write the job description, they are not doing their job. What happens in this situation? Does anyone have ultimate control over the ECB? Or was the possibility that the ECB would not do their job properly never imagined?