Some considerations for ECB’s Policy Review

A higher inflation target or average inflation targeting?

In this paper, Andrade et al., analyze the monetary policy options for the ECB in an environment of low r*. They use a New Keynesian DSGE model which they estimate for the euro area from 1985Q1 to 2008Q3, using the period of Great Moderation as a benchmark for comparison with the “new normal” of lower natural rate of interest. Their model includes imperfect indexation of prices to non-zero trend inflation as well as imperfect indexation of wages to both inflation and technical progress. Finally, there is a lower bound constraint on the nominal interest rate. They find:

• Not changing the monetary policy strategy is suboptimal;
• A 1 percentage point decrease in r* from its pre-2008 level calls for an increase in the the inflation target of roughly a 0.8 percentage point when the policy rule is unchanged;
• The adoption of policies that make up for the inflation lost during ELB episodes, such as average inflation targeting, can be an alternative to increasing the target if the commitment to making up for inflation lost during ELB episodes is strong and credible enough.

Should the ECB Adjust its Strategy in the Face of a Lower r*?
Authors: Philippe Andrade, Jordi Galí, Hervé Le Bihan, Julien Matheron
From: Federal Reserve Bank of Boston, CREI, UPF and Barcelona GSE, Banque de France

Is the ECB more averse to high or low inflation?

This is the question Paloviita et al. are seeking to answer in this paper. They use text mining techniques (natural language processing) to analyze the introductory statements of the ECB’s press conferences in order to “read between the lines” and infer the ECB’s preferences.

Our analyses indicate that if we assume a priori that the ECB has conducted symmetric monetary policy, estimates of the de facto inflation target of the ECB are relatively low (1.7%). If, however, we fix the de facto inflation target to the upper bound of the price stability definition (2%), the loss function estimation reveals asymmetric preferences to inflation.

Reading between the lines − Using text analysis to estimate the loss function of the ECB
Authors: Maritta Paloviita, Markus Haavio, Pirkka Jalasjoki, Juha Kilponen, Ilona Vänni
From: Bank of Finland

Considerations for the ECB’s Policy Strategy Review

In this paper Athanasios Orphanides argues that the ECB is faced with two challenges: a) the “lowflation” problem, the result of tight policies that led inflation to drift considerably below 2% over the past several years; b)  the “impairment” of the monetary policy transmission mechanism in the euro area, a factor that contributes to the divergent economic performance of member states. What should the ECB do?

• Adopt a clear, symmetric 2 percent inflation goal and calibrate QE in a systematic matter to achieve this goal. Both these steps would help re-anchor inflation expectations;
• Eliminate cliff effects in its collateral framework on a permanent basis and end the delegation of the determination of collateral eligibility of government debt to private credit rating agencies.

The ECB’s Instruments for Crises and Normal Times: Considerations for the Policy Strategy Review
Author: Athanasios Orphanides
From: MIT