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Ladies and Gentlemen, Dear Friends,
It is a great pleasure for me to welcome you all to the Bank of Finland webinar on New Challenges to Monetary Policy Strategies. We are streaming the event from our Monetary Museum in Helsinki. I would like to extend a special welcome to a large group of invited guests in Teams. I look forward to a productive debate this afternoon.
In my opening remarks, I’d like to briefly lay the ground for the two main subjects of the webinar. Firstly, as this webinar will focus on the core analytical matters in the European Central Bank’s ongoing strategy review, I will say a few words on its background and key issues. Secondly, I will discuss new challenges raised by the COVID-19 pandemic, particularly the interaction between monetary and fiscal policy, which has become an increasingly strategic issue in the context of the current crisis.
PRIMARY OBJECTIVES OF THE ECB
The essential rationale of the review was elegantly coined by President Christine Lagarde recently: “We need to thoroughly analyse the forces that are driving inflation dynamics today, and consider whether and how we should adjust our policy strategy in response.” With that in mind, and to set the scene, let me explore what has been the evolutionary road of the ECB’s monetary policy strategy during its relatively short history.
As the European Union is fundamentally a community of law, it is worth reminding ourselves of the legal base of monetary policy: the EU Treaty defines price stability as the primary objective of the Eurosystem. Clear enough, but how has price stability been defined so far? That is perhaps less clear.
In October 1998, the Governing Council announced a quantitative definition of price stability, which was defined as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%”. That was interpreted as a range between 0 and 2%, and the main focus was on combating too high inflation.
After reasonable success in achieving that aim, the first review of the strategy was launched half a decade later in 2003. The project was aimed at promoting public understanding of the ECB’s policy goals, strategy and actions. In the end, the Governing Council confirmed the definition adopted in 1998, but supplemented it with an aim of “below, but close to, 2%” for the inflation target.
This was expected to provide a safety margin against deflation risks and an inflation buffer for the labour market, as well as enough room to facilitate relative price adjustment in the monetary union. However, setting the inflation target at the upper bound of the price stability definition generated a perception of asymmetry and ambiguity on the target. This will be discussed by Dr. Juha Kilponen in the first session today.
In a way similar to other major central banks that have adopted a framework of flexible inflation targeting, the ECB’s current monetary policy strategy includes two additional key elements. The first is that price stability is a forward-looking concept that is to be maintained over the medium term. The second is that the ECB is mandated “without prejudice to price stability” to support the general economic policies of the Union. And this is not a mere footnote, since when reading the EU Treaties (article 127 of the TFEU and 3 of the TEU), “without prejudice to the objective of price stability”, we as the Eurosystem are pledged to “work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress”.
Hence, I find the sometimes passionate debate that every now and then pops up on the need for a ‘dual mandate’ rather pointless, almost like shadowboxing. It is already in the Treaty, unless we call it a ‘triple’ or ‘quattro’ mandate, since if we respect our legal mandate we need to aim at achieving full employment, balanced growth and sustainable development – indeed as long as price stability is not compromised.
ECB STRATEGY REVIEW
So much for the historical and legal background. In January this year, the ECB launched a new strategy review of its monetary policy framework, but unfortunately this had to be postponed for half a year due to the COVID-19 outbreak. The review was re-launched in September this year and is expected to be completed by September next year.
The review is…