July 26, 2021

European Central Bank ready to let inflation exceed 2%

Christine Lagarde will have succeeded in taking the small world of central bankers by surprise by announcing the results of her strategic review much earlier than expected, which were expected in the fall. The President of the European Central Bank (ECB) presented them during a surprise press conference Thursday, July 8. It announces a technical but important dusting of the functioning of the institution of Frankfurt, pillar of the euro zone.

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Main conclusion: the ECB explicitly recognizes that it is ready to let inflation exceed its 2% target “Temporarily” if prices have previously been below that level. “The 2% is not a ceiling”, underlines Mme Lagarde.

Allowing the economy to overheat slightly is a good thing to allow the recovery to take hold, says ECB

The subject is at the heart of the current economic debate. Inflation in the euro zone is currently at 2% and should increase in the coming months. But this is an exit effect from the pandemic, while the euro zone was briefly in disinflation in the fall of 2020. In this context, letting the economy slightly overheat is a good thing, to allow the recovery of take root, believes the ECB. This is to avoid the serious mistakes made by the institution at the start of the euro zone crisis a decade ago, when interest rates were raised while the recovery was still very fragile.

This new inflation target makes it possible to put an end to the bizarre compromise reached by the ECB during its last strategic review in 2003, eighteen years ago. At the time, it had been defined as “Below but close to 2%”, which represented a victory for the very orthodox German Bundesbank which especially did not want to let the prices slip.

Since then, every President of the ECB has been forced to refer to this convoluted sentence. Now the new target is much simpler: 2%. Above all, it is “Symmetrical. “ Clearly, being above or below is “Also undesirable”, explains Mme The guard. There is no longer a systematic bias in staying too low. “This new objective marks the end of the Bundesbank tradition of the ECB”, says Andrew Kenningham, an economist at the research firm Capital Economics.

“Not a revolution”

How far will the ECB be prepared to go? In the United States, the American Federal Reserve has already announced a target of “Symmetry” inflation in the fall of 2020. Today, the rise in prices has reached 5% but the Fed still refuses to tighten its monetary policy, believing that the phenomenon is temporary. In his press conference, Mme Lagarde tried to disassociate himself from this approach, pointing out that his strategy was different from that of the Fed and hinting that it would likely be less tolerant.

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