The ECB has an inflation target. How do the Germans propose they hit it?
By Scott Sumner
The Germans have traditionally argued that the ECB should focus like a laser on their inflation target, paying no attention to unemployment. Fair enough. But how are they supposed to do this?
The exact target is kind of vague, below 2% but close to 2%. It’s a really bad idea to define the inflation target that way, which makes it seem obvious that it was a political compromise. Most pundits seem to assume the actual target is somewhere around 1.8%.
The ECB’s tight money policy since 2007 has led to extremely slow NGDP growth, and just as in Japan the eurozone has fallen into a zero rate trap that looks semi-permanent. Also note that this is partly because of the German influence at the ECB. They favored higher interest rates in 2011, which is precisely the sort of policy that drove them deep into the zero rate territory. As a practical matter, the long run zero rate environment is a German policy.
(Ironically, they were concerned about their savers receiving low returns. Just one more reason to be skeptical that “self-interest” explains monetary policy screw-ups. Even most experts have no idea how monetary policy actually affects the economy.)
But this raises an interesting question, and one I have not seen discussed in the blogosphere. If the Germans insist on a policy that leads to ultra-slow NGDP growth, and the resulting zero interest rates, then the ECB cannot use a Taylor Principle-type approach to inflation targeting. The standard tool of almost all central banks. So what policy instrument do the Germans want the ECB to use, if not short-term interest rates? One obvious choice is negative rates on reserves, but I recall reading that the Germans are opposed. Another is QE, but I recall reading that the Germans are opposed. So over the next few decades when the eurozone is stuck at zero, what sort of policy tool do the Germans want the ECB to use in order to hit its 1.8% inflation target?
These things don’t just happen by accident.
PS. Over the years some commenters have told me that they “don’t favor using monetary policy.” If the Germans take that approach they may be in for a nasty surprise. You may not care about monetary policy, but monetary policy most certainly does care about you.