Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 8 October 2014

Defining price stability

Price stability is the primary objective of the ECB, as laid down in the Treaty on the Functioning of the European Union, Article 127 (1). The ECB gets to choose how to interpret price stability, and it does this as “inflation rates below, but close to, 2% over the medium term.” Why ‘below but close to’? If this means 1.8% or 1.9%, it would seem very odd. How do the ECB know that 1.8% inflation is the right target?

I suspect the answer is that this formulation is a compromise, between those who wanted a commitment to inflation below 2% (which could mean zero) and those that wanted just 2%. Is this constructive ambiguity? I cannot see how it can be. The whole point about inflation targeting is to provide a clear signal about the objectives of the monetary authority.

Now this would not matter much if everyone involved in ECB monetary policy was of one mind. However they clearly are not. Here is J├╝rgen Stark, who was sometimes referred to as chief economist of the ECB until he left at the end of 2011, talking about the current conjuncture:

“The current inflation rate of 0.3% is due to the significant decline in commodity prices and the painful but unavoidable adjustment of costs and prices in the peripheral countries. Only Greece currently has a slightly negative inflation rate. In other words, price stability reigns in the eurozone. This strengthens purchasing power and ultimately private consumption. The ECB has fulfilled its mandate for the present and the foreseeable future. There is no need for policy action in the short term.”

Are these views of the past? Or do some who continue to sit on the Governing Council still have sympathy for these views? Is this about principle, or national interest: ECB rates were cut substantially when the German economy was weak in 2002-5, rather than let inflation fall below 2%. Speculation of this kind is fine for those who make money from it, but inflation targets should be clear and unambiguous. Allowing people to believe that maybe the ECB is not too bothered about below 2% inflation could be very dangerous because of the zero lower bound.

The solution to this problem seems terribly straightforward. All the academic discussion is about whether inflation targets should be higher than 2%, not lower, because the chances of hitting the zero lower bound are clearly greater than had been thought. With Stark and others no longer there, perhaps the ECB can agree (by majority vote if necessary) to target just 2%, and those that cannot abide by that decision can leave - as Stark officially did - for 'personal reasons'. If the ECB cannot do this by themselves, then Eurozone governments should tell them to do this. I have never understood why the inflation target itself should be something that is decided behind the closed doors of central banks.

One final thought on the Stark article. He too uses the phrase “Anglo-Saxon economists”. I am at a loss to know what this is meant to signify. For a few who comment on my posts it means that we are part of a plot to ensure the Eurozone fails, but is this what Stark means? Perhaps there is some reason why the theories of economics developed in the UK and US do not apply in the Eurozone. However the work I have seen done by ECB economists would not look out of place if done at the Fed or IMF, and from his experience Stark must know this. Some people refer to ordoliberalism. But if ordoliberalism differs from Anglo-Saxon neoliberalism in theory rather than practice, it seems to me this is because it takes more rather than less notice of mainstream economics. If it means disagreeing with almost everything in the paragraph of his quoted above, then I think many non-Anglo-Saxon economists would be in that group. Perhaps, like the phrase ‘below but close to 2%’, we will never know quite what it means.


  1. Interesting contrast with regional Fed President Kocherlakota in the U.S. who having looked at the evidence these past few years has reversed positions. From a speech yesterday:

    "Why do I see symmetry as important? Without symmetry, inflation might spend considerably more time below 2 percent than above 2 percent. Inflation persistently below the 2 percent target could create doubts in households and businesses about whether the FOMC is truly aiming for 2 percent inflation, or some lower number. This kind of unmooring of inflation expectations would reduce the effectiveness of monetary policy as a mitigant against adverse macroeconomic shocks.

    Second, I believe that the FOMC should consider articulating a benchmark two-year time horizon for returning inflation to the 2 percent goal. (Two years is a good choice for a benchmark because monetary policy is generally thought to affect inflation with about a two-year lag.) Right now, although the FOMC has a 2 percent inflation objective over the long run, it has not specified any time frame for achieving that objective. This lack of specificity suggests that appropriate monetary policy might engender inflation that is far from the 2 percent target for years at a time and thereby creates undue inflation (and related employment) uncertainty."

    The story in the U.S. is that 2 percent was chosen as a compromise between Yellen and Greenspan who had suggested zero.


    "In July 1996, the Federal Reserve broke the metronomic routine of its closed-door policy-making meetings to hold an unusual debate. The Fed’s powerful chairman, Alan Greenspan, saw a chance for the first time in decades to drive annual inflation all the way down to zero, achieving the price stability he had long regarded as the central bank’s primary mission.

    But Janet L. Yellen, then a relatively new and little-known Fed governor, talked Mr. Greenspan to a standstill that day, arguing that a little inflation was a good thing. She marshaled academic research that showed it would reduce the depth and frequency of recessions, articulating a view that has prevailed at the Fed. And as the Fed’s vice chairwoman since 2010, Ms. Yellen has played a leading role in cementing the central bank’s commitment to keep prices rising about 2 percent each year."


  3. i thought anglo saxon was a racist term like south americans gringo

    i see stark favors reform and private initiatives doesnt think that high unemployment and perma recession is enough

    should be a bingo grid for these types of people

    1. i do not think that it is racism; i think that anglo-saxon refers to intellectual and cultural imperialism from the US and GB. That means not liking intellectual developments from these countries and espeically not liking people such as Paul Krugman and to a lesser extent Wren Lewis - who is at least nomimally a European.

      My experience with a group of French students in the steates who had graduated from the Ecole Normale Superior informed my opionion.

    2. Anglso Saxon in Germany is definitely a negative label. Whereas previously it was used to attack the Milton Friedmans, now it is used to attack the Paul Krugmans. The intent is the same - to signify them as the "other."

  4. Dear Sir,

    you write:
    'I have never understood why the inflation target itself should be something that is decided behind the closed doors of central banks.'

    The whole purpose of independent central banks is to take away the money spigot away from governments who cannot be entrusted with them. The temptation to bribe voters with freshly printed money is too great. Governments must not have control over the inflation rate; instead, the idea is to have a body that is devoted above all other things to keeping prices fairly stable.

    From that perspective, having a 0% inflation rate in a quarter is not a drama. The prices are stable enough and the central bank is doing its job. The central bank is not intended to pay too much attention to what this does to debt dynamics. It is solely the job of national governments to keep those in check. I believe that from the viewpoint of ordoliberalism this is not a bug, it is a feature. Remember that German ordoliberalism propagates a relatively strict seperation of concerns.

    You write furthermore:
    'One final thought on the Stark article. He too uses the phrase “Anglo-Saxon economists”. I am at a loss to know what this is meant to signify.'

    This is very speculative on my part but I think it refers to economists that fear deflation more than inflation. Economists that do not believe in ordoliberlism's separation of concerns. Economists that see a wider role for monetary policy than "price stability first and foremost'. As such, it is probably more a state of mind.

    Conversely, I believe ordoliberalism does not see much of a role for monetary policy to affect the unemployment rate. Not that it cannot be done, it is simply not the concern of a central bank that has been founded on ordoliberlism. It is the concern of the "Tarifpartner" (via wage negotiations) or the government (via fiscal policy) to affect that.

    1. We are no longer in the 1920s. I think we can trust advanced economy governments to set an inflation target.

      You talk about 0% inflation as no big deal, as if this was completely unconnected with high unemployment outside Germany. The job of a central bank is to hit an inflation target by managing demand. Basic macro, which they teach in Europe as well as UK/US. If ordoliberalism does not understand that, it will either change or wither away.

    2. Dear Sir,

      you write:

      "We are no longer in the 1920s. I think we can trust advanced economy governments to set an inflation target."

      On that we have to agree to disagree, I fear.

      You write furthermore:
      "You talk about 0% inflation as no big deal, as if this was completely unconnected with high unemployment outside Germany."

      The 0% inflation did not come about by coincidence. It was the goal of austerity policies - to bring down prices of crisis countries versus the rest of the world. This is not a bug but was intended as a feature. We can debate the folly of that approach but I think it would be beneficial to this debate if we did not create the impression that it was an unwanted side-effect of austerity. Internal devaluation is deflationary by design, as far as I understand it.

      I should add that I do not make a spokesperson of ordoliberalism by any means and am talking only based on my own limited (read: amateurish) understanding. So any reader best take everything with a huge grain of salt.

  5. Apropos 'Anglo-Saxon economists'.

    Modern inflation targeting was pioneered in New Zealand in 1989 and in Canada in 1991, coming to the UK in the autumn of 1992.

    So, if anything, the Eurozone in making Anglo-Saxon assumptions by having an inflation target, unless they are getting in touch with their 1930s Swedish roots.

    1. That should be 'the Eurozone is making' not 'in making': I should read my posts better before submitting.

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  7. Could you please explain what the ECB should do to get exactly 2% inflation?

    1. Good question! I doubt that you will get an answer.

    2. The problem is that the rules in the Maastricht treaty that govern what the ECB can do are unnecessarily restrictive and essentially hand Germany a veto. Without reform of the treaty it's going to be very difficult for the ECB to raise inflation to 2% by itself. Unfortunately few politicians want to even acknowledge the possibility of reform. They have very effectively moved such ideas beyond the political pale. Suggest it to a politician and it gets dismissed with the most curious justifications. My favourite is the one that says reform takes time and is therefore not a solution to immediate problems. Nevermind it's been six years since the crisis started...

  8. I don't think ordoliberalism is the correct word to describe the economic model of not just Germany, but the whole of Northern Europe. Social market economy or Rhineland model is a more used word in those countries
    my take on ''anglo-saxon'' versus social market economics: the objectives and theory might be roughly the same, but the way how to get there is different.
    US and UK economies are much more liberalized, therefore the main policy instruments left that economists concentrate on seem to be fiscal and monetary policies.
    In the eurozone the role of the state is much larger, therefore the range of policy instruments is more broad.
    The term ''structural reforms'' is often looked upon with some disdain on ''ango-saxon'' blogs, which is maybe not surprising if you leave the economy to the market.
    But what if your economy is a mixed economy where the state, and not the market, controls wages, education, housing market, large companies with a government shareholding and already higher taxes are used to steer the economy? Maybe you need to put less emphasis on fiscal and monetary policy, as these seem to be quite blunt instruments.
    If running a successful economy was purely about fiscal and monetary policy, than all countries in the world would be affluent.

  9. there are economic decisions that have to do with long-term development, containment of corruption, education, technological innovation, and then there are issues dealing with the short term question of getting the economy back to potential in a recession. they require different methods.

    1. But what is the point of doing the short term stuff, if you don't tackle the long term development? I think this is the key criticism towards a country like Italy.
      I do read a lot Germany bashing on this blog regarding economic policy, but I am still waiting on the first post about needed structural reforms in some eurozone countries.
      If the eurozone cannot find a way to connect these two, than all fiscal or monetary stimulus for some countries is just a waste of time and money.
      These are not just my words, or from Germany, but from Draghi

    2. Anonymous9 October 2014 06:55

      What you don't realise is that Draghi is a ghastly deflationist, as SWL has pointed out. Sometimes he says things that please SWL, but then the cloven hoof appears.

      SWL is so right: What Draghi should do is spend, spend, spend. After all, in the long term, we shall all be dead (but not our children - but who cares for them?)

    3. if you want to pay down the debt, it makes sense to put people to work and that means a stimulus and possibly QE in this case. Cutting spending in a depression only deepens the problem. If you want to address spending problems, address them with the proviso that the economy is fully utilizing its resources of capital and labor.

      Deepening a depression by cutting spending is going to make repayment of debt that much harder.

      Paying back loans is a lot easier once you are employed.

    4. Except for Greece, the rest of the PIIGs and France had controlled their spending; I am not sure how much structural reform would be needed (except in Greece, of course) if the economies were performing up to their potential

  10. yes, you all keep repeating the same dogma: spend and you will get out of the depression, and be able to pay back the debt. Well, it didn't work out for Japan. Sure, you will have an explanation for this too. But maybe better start with trying to change this: since the economic crisis, there is no confidence in your economic theories anymore among the general public.

    1. sure, even in the USA the public does not believe in simtulus or QE, granted, though stimulus and QE has gotten the US out of this mess while GB and Europe are stuck.

      of course, you have an explanation for that.

  11. Anglo-Saxon economists...

    ...think there are simple solutions to improve economies (see #2)

    ...believe growth is the solution to all problems

    ...never use the word "sustainable" when talking about growth

    ...think less population growth is a problem rather than a solution to a problem

    ...think only demand and not supply should be adjusted in a recession

    ...don't fear debt

    ...quote Keynes as if he were a prophet

    ...use GDP (or unemployment) and not well-being as a proxy for a country's economic condition (and so this explains largely why they think growth solves all problems)

    ...consistently advocate policies which make the rich get richer (see the "market knows best" dogma before 2008, and QE afterwards)

    ...use metaphors like "rocket ship" and "take-off velocity" to represent the economy when talking about the effects of stimulus

    ...don't like metaphors like "household" to represent the government in its management of the economy

    ...think with a few tweaks (a little more regulation, maybe a few more taxes on the rich) Anglo-Saxon economies like the US and the UK will be just fine


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