“Refocusing the ECB on output stabilisation and growth through inflation targeting”

1. “Refocusing the ECB on output stabilisation and growth through inflation targeting” Jörg Bibow, Franklin College Switzerland Delivering the Lisbon goals: The role of macro economic policy making1-2 March 2005, Brussels, CES-ETUC

2. Inflation targeting [IT] – or not? • Many observers view ECB as an inflation targeter by deeds even if not by words – this is wrong! • ECB rejects IT and follows ‘two-pillar strategy’ instead, claiming that by delivering on primary goal of price stability it would thereby also fulfil its growth & stabilisation mandate – wrong too! • What may be right though is that imposing IT upon the ECB could lead to both better growth as well as inflation performance in future. J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

3. ECB: Inflation targeter in disguise? • Some observers believe that ECB’s interest rate policies (its ‘deeds’) have been much in line with what IT would have required (CEPR etc). • In this view, ECB – for some reason – tries to obfuscate its IT approach; lack of transparency and bank’s confusing ‘words’ are regrettable. • That the ECB ‘allowed’ inflation to stay above two percent for five years in a row is seen as evidence for flexible approach to IT and concern for growth. J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

4. Actually, ECB’s words & deeds do match – but are both inappropriate! • From the beginning M3 pillar was meant to continue Buba tradition of hiding policy discretion behind pseudo-monetarist veil. • From the beginning price stability pillar fully reflected another Buba tradition, namely that sound (‘stability-oriented’) monetary driver is quick in hitting the brake, but abstains from using accelerator – ASYMMETRY!!! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

5. Why asymmetry worked for Buba • Buba approach worked fine for Germany when nominal exchange rates [ER] were stable, trading partners’ inflation higher, and accelerator applied skillfully ‘elsewhere in the world economy’. • Troubles emerged as partners’ inflated converged a/o ER developments put spanner in the works. • While lacking any skills & experience in properly managing the economy, Buba held a big success. • Buba & Buba wisdom blueprint for Maastricht EMU! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

6. What Maastricht meant • To Germany – exporting Buba ‘success story’ undermined its working at home • Provoking deflation as Germany stubbornly goes old way … • To Euroland – emulating Buba ‘success story’ = asymmetric ‘management’ of domestic demand • Mr Buba Otmar Issing represents this ‘culture’ 100% • To rest of world – as German disease spreads rudderless economic giant drifts along hoping for strong enough export currents to pull it along • Global imbalances … J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

7. Understanding the current mess • Neither ‘external shocks’ nor ‘structural problems’ are to blame • Instead ECB’s asymmetric policies key to protracted domestic demand stagnation • Series of severe policy blunders • Imposing IT upon ECB should stop it from reneging on its growth & stabilisation mandate, and lead to better inflation performance too! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

8. What inflation targeting is all about • Forward-looking: keeping tomorrow’s rather than yesterday’s inflation stable around target • ‘Inflation forecast targeting’ • Symmetry – deviations in either direction unwelcome • Inevitably, any short-term inflation forecast derived from forecasted evolution of economy. • Effectively, IT means actively managing aggregate demand and employment, and thereby inflation – requiring skills & competence! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

9. Bank of EnglandInflation targeting success story • Publication of MPC’s forecast of inflation two years out – basis of policy & communication • Model of transparency & openness in all respects • Frequent & symmetric interest rate adjustments • Smooth cooperation with fiscal policy • Robust and fairly stable wage inflation • Outcome: Very stable nominal (& real) GDP growth, high employment, and low inflation • NB: UK’s problems relate to operating in the immediate vicinity of stagnating economic giant. J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

10. IT not at all what ECB does! Revisiting ECB’s key blunders • (1) Market opposition and the ‘euro puzzle’ • (2) Productivity slump boosts core inflation • (3) Stagnation pushes ‘Instability & Stagnation Pact’ into reverse gear – ‘tax-push inflation’ • Result: ECB low on ammunition as strong euro prevents yet another free-ride on successful US demand management – euro area seems trapped in a vicious circle of its own making! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

11. Blunder no. 1: Crashing the euro • ‘Repeating a pattern observed in 1999 and 2000, monetary policy decisions and interest rate differentials [in 2001 too] appeared to influence exchange rates mostly through their effect on growth expectations’ (BIS 2002: 86). J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

12. Blunder no. 2: ‘wait and see’ • After nearly doubling policy rates within 11 months, thereby crushing domestic demand, ECB had trouble getting its foot off the brake (not to mention using the accelerator as aggressively). • ECB’s ‘caution’ provoked severe productivity slowdown and corresponding rise in unit-labour costs and core inflation • ECB’s rear-mirror view meant more ‘caution’, and hence more stagnation too ... J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

13. Business of keeping up margins! Despite very low & stable wage inflation, ‘preemptive’ punishment of employees! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

14. Blunder no. 3: ‘tax-push inflation’ • As ‘first line of defense’ (Koehler, IMF) fails, Buba fiscal wisdom kicks in with a vengeance • Among ever more desperate but vain attempts at pro-cyclical consolidation, hikes in indirect taxes and administered taxes feature prominently • Conspicuous phenomenon: ‘tax-push inflation’ • This upward distortion in headline HICP is behind ECB’s astonishing failure on its primary goal! • Clearest evidence on counterproductive macro policies! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

15. Reneging on growth may not pay off 0.7% Mind the gap! ‘tax-push inflation’ J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

16. Monetary & fiscal policy interaction à la Buba/Maastricht J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

17. What proper inflation targeter would NOT do: • Misread & provoke markets so that currency crash pushes inflation up • Carelessly & needlessly provoke productivity slump that pushes inflation up • Ignoring stagnation and unemployment since resulting fiscal squeeze pushes inflation up • Even for the sake of maintaining price stability itself proper inflation targeter has an interest in sustaining growth & employment, and thereby low inflation. J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

18. IT and wages – two cases • (1) Wages responsive to economy – both ways! • Implies linear (upward-sloping) supply curve • This should go with relatively higher inflation target • (2) Wage inflation unresponsive to economy • Implies nonlinear supply curve (with flat range) • Wage rigidity provides safeguard against deflation, allowing a relatively lower inflation target. • Keynes (1936, ch. 19) argued that case (2 – stable wage unit) actually makes it easier to run stabilising monetary policy. J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

19. Euroland: Stable & (too) low wage inflation – and asymmetric MP Output & employment costs due to two factors: • (1) price ceiling (‘below 2%’) may be too low • (2) interest-rate policies asymmetric and systematically misguided • VERY ‘forward-looking’ on output recovery & inflation risks • Complacent about slump and deflation risks • Anti-growth bias even costly in terms of inflation • Inflation above two percent for five years is really a miracle! • Employees/consumers hit by double-whammy!!! J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

20. Perhaps better end this folly? J Bibow, Franklin College ETUC, Brussels 2 Mar 2005

21. So what to do about it? Structural reform! • (1) institutions • End antiquated Buba-style central bank independence, i.e. ‘Unbounded discretion’ & despotism in MP • Both undemocratic & economically inefficient! • Bank of England may serve as model of CBI • Impose IT upon ECB! • (2) personalities • End series of ‘accidents of personality’(MF) in Frankfurt • Select central bankers who are willing and able to MANAGE the economy and thereby inflation, since that is what is required – inevitably! • Please refer to www.levy.org for my research working papers on EMU. J Bibow, Franklin College ETUC, Brussels 2 Mar 2005