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On January 23, 2020, the European Central Bank (ECB) logo was seen in Frankfurt, Germany. Ralph Orlowski/REUTERS Reuters, FRANKFURT, July 8 – On Thursday, the European Central Bank announced a new inflation target and a larger role in the battle against climate change, as Europe’s most powerful financial institution underwent the most significant revamp in its 23-year history. With inflation having been below target for nearly a decade, ECB President Christine Lagarde has led an 18-month investigation into the bank’s inner workings, questioning even basic central banking fundamentals in the aim of resetting policy and restoring credibility. In a crucial conclusion of the study, the central banks of the 19 euro-area nations established their medium-term inflation target at 2%, abandoning a prior formulation of “below but close to 2%,” which gave the impression that they were more concerned about price growth beyond the target than below it. Inflation-targeting, which was first implemented in the early 1990s by smaller central banks in New Zealand and Canada, is widely regarded with controlling price increases and ushering in a period of price stability, with the youngest generations having little experience with real inflation. However, the experiment’s results have been mixed, particularly in the last decade, when some of the world’s largest central banks, such as the European Central Bank and the Bank of Japan, have struggled with excessively low inflation, forcing them to cut interest rates into negative territory and casting doubt on central banks’ power. The prospect of targeting an inflation rate beyond the target had been raised as a result of the chronic undershooting, but the ECB finally decided that price growth above and below its target were both undesirable, and it would not strive to overshoot even after extended periods of low inflation. “This aim is symmetric,” the ECB explained, “meaning that both negative and positive deviations from the target are undesirable.” OVERSHOOTING The bank acknowledged that in some circumstances, when extra forceful or long-term monetary support is required, inflation may moderately exceed its target for a short time. However, the new policy did not commit to an inflation overshoot after extended periods of low price growth, potentially disappointing investors who expected such a guarantee to assure stimulus well into the recovery. Recognizing that inflation might still briefly exceed its target was seen as improving the ECB’s credibility with markets, demonstrating that its target is symmetric and policymakers do not regard 2% as a ceiling, a problem the bank had with its prior target. The ECB also expressed dissatisfaction with the existing gauge of inflation compiled by the EU’s statistics agency, claiming that it missed substantial parts of housing expenses. However, because any change would take years, officials would consider different inflation measures. “The Governing Council will enhance its set of broader inflation indicators with inflation measures that incorporate first estimates of the cost of owner-occupied housing in its monetary policy evaluations,” the ECB said. The central bank stated that it will do more to aid in the battle against climate change, and that climate change concerns will be included in monetary policy operations in the areas of disclosure, risk assessment, collateral framework, and corporate sector asset acquisitions. “In keeping with its mandate, the ECB will amend the framework guiding the distribution of corporate bond purchases to integrate climate change factors,” it stated. By the first quarter of 2023, the bank will begin providing climate-related information from its corporate sector asset acquisition program. The ECB is following the Federal Reserve of the United States into social policy by taking on a climate role. Following a similar study last year, the Federal Reserve announced that it will allow the job market to run hotter in the future to support low-income families, potentially reducing inequality. Balazs Koranyi contributed reporting, and Catherine Evans edited the piece. The Thomson Reuters Trust Principles are our standards./nRead More

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