( This is an assisted AI-translation of https://24plus.ilsole24ore.com/art/una-nuova-fase-la-bce-ecco-errori-evitare-AGBgYylB )

The Eurozone has entered a new phase. In December, the European Central Bank missed the opportunity to formally close the chapter on high inflation and open a new one. However, the data suggests that profound changes are indeed underway. The decline in long-term inflation expectations below 2% is a significant development, and equally notable are the ECB’s own projections, which foresee an average annual inflation rate of 1.9% in 2026—well within its monetary policy horizon. This indicates that the inflation target is, in some sense, within reach.

Toward normalization

It’s true: victory over inflation cannot yet be declared. President Christine Lagarde is correct in maintaining caution, and monetary policy appropriately remains restrictive—if only to properly account for the risks of price acceleration. Yet, if the neutral rate—estimated in some ECB analyses at 2.50% (0.50% real rate plus 2% inflation)—is taken as a reference, the deposit rate currently set at 3% strongly suggests that the phase of normalization is nearing its conclusion.

The end of the “non-conventional” era

This is an opportune moment to take stock. The ECB’s recent past has been turbulent: the 2008 financial crisis, the 2010 fiscal crisis and the prolonged lowflation period tackled with massive quantitative easing and negative rates, the pandemic, and now the inflationary surge. Nearly every aspect of recent monetary policy has been “non-conventional.” As we prepare for what one hopes will be a period of relative normalcy—trade wars permitting—it might also be time to reassess the deviations imposed on monetary policy. These deviations could well be regarded as outright errors that should be avoided in the future.

Monetary objectives

The first deviation concerns monetary policy’s departure from its own objectives, which are, unsurprisingly, monetary in nature. Inflation must once again take center stage. The delay in addressing the price acceleration that began in July 2021 (with the first rate hike coming only a year later) resulted in significant costs. It’s true that the initial situation appeared ambiguous—it seemed to be “supply-side inflation,” which monetary policy traditionally avoids countering. Yet, the ECB is well aware, and has extensively studied in the past, what happens when energy shocks hit prices. The response delay was excessive.

The centrality of inflation

Now is the most opportune moment to focus exclusively on inflation. The ECB’s mandate risks being “watered down” by political pressures. Even Emmanuel Macron, in the recent past, suggested exploring how growth might be incorporated as an objective for the central bank. Others, including some in Italy, have been more explicit and less cautious. This is a mistake because monetary policy is not a growth engine. With public finances under significant strain—amid numerous and often excessive demands for public intervention, including now military spending—there is a growing desire for low borrowing costs, and thus low interest rates. The ECB has often been asked, directly or indirectly, to support public debt under various pretexts of varying credibility. The result has been predictable and consistent: governments and companies (sometimes already zombie firms, doomed to fail) have been encouraged to increase their debt, exacerbating financial imbalances and creating fertile ground for inflation.

Separating monetary and fiscal policy

The desire to combat climate change—which also reflects a broader goal of reducing the Eurozone’s dependence on unstable or unreliable oil-producing countries—has led the ECB (like many other central banks) to adopt “green” objectives. However, these belong to the fiscal sphere, not the monetary one. The separation between fiscal and monetary objectives, while not always clear-cut in practice, remains essential. Democracy—understood here as representative democracy—was born out of debates over public spending and the taxation it entails. Entrusting a portion of monetary policy to independent institutions was a necessity: governments are too inclined to overspend and therefore to seek excessively low interest rates, which risk fueling inflation. While the independence of central banks cannot be compromised, the issue of monetary policy’s democratic legitimacy remains central. Beyond parliamentary hearings, this must be addressed through two key principles: accountability and transparency.

The loss of transparency

The latest phase of monetary policy, marked by uncertainty over price dynamics, has led the ECB to retreat from transparency. Like the Federal Reserve, the ECB has abandoned forward guidance—explicit indications of future policy actions. Other central banks continue to use this tool, often in more advanced forms than those tested in the Eurozone. For instance, some explicitly announce the future trajectory of interest rates. The ECB, by contrast, has opted for a “meeting-by-meeting” approach, forfeiting the ability to influence financial markets more effectively and achieve its objectives with less effort. This has heightened uncertainty, reduced the efficiency of its actions, and made its decision-making process more opaque.

A return to greater transparency is necessary, both operationally and politically. In a European Union increasingly criticized for its democratic deficit, the transparency of the ECB—the most powerful and arguably the most “communitarian” of its institutions—is of paramount importance.

Denied impartiality

Even more crucial is the impartiality of monetary policy with respect to income redistribution. In 2021, the ECB adopted a “symmetric” inflation target. This means that it now addresses overheating prices—where a preventive approach is warranted, given the potential costs to growth—in the same way as it tackles disinflation or deflation. While this is an elegant solution, it is also inefficient and unjust.

The two inflation regimes

Research by the Bank for International Settlements (BIS) highlights that inflation and deflation behave very differently. Disinflation and deflation tend to stabilize themselves, whereas inflation is prone to spiraling out of control. This is a critical distinction, as outlined in a study by Claudio Borio, Marco Jacopo Lombardi, James Yetman, and Egon Zakrajsek (The two-regime view of inflation), later summarized in the BIS’s 2022 Annual Report.

Missed objectives

In recent years, the ECB has fought both low inflation—which was likely “good” inflation, stemming not from weak demand but from productivity gains transmitted via global trade—and high inflation, albeit with insufficient timeliness. Had things gone as desired, real wages for workers (and others) would have been prevented from rising healthily and across the board, while inflation was allowed to cut them sharply instead. Not all the results, fortunately one might say, were as intended: between 2012 (the start of the zero-interest-rate policy) and 2019, wages in France increased by 6% (OECD data, adjusted for purchasing power), in Germany by 11%, and even in Italy by 2.4%. (However, real wages in Italy today are 3% lower than in 2000 and 8% below their 2010 peak. Italy’s issues, however, lie elsewhere.)

An abstract symmetry

Following the emergency rescue of the euro—the famous “whatever it takes”—the era of negative rates and quantitative easing failed to stabilize inflation at 2%. Instead, it incentivized zombie firms and governments to take on unsustainable debt, heightened financial market imbalances, and contributed to price overheating. It did not support economic activity, because—as bears repeating—monetary policy is not a growth engine. This policy favored debtors at the expense of creditors, justified by an abstract symmetry. Some of the mistrust in liberal systems—unjustified and dangerous but understandable, given the conservative distortions they have undergone—can be traced back to these imbalances.

The inflation bogeyman

This was a conscious choice. Before 2003, the ECB had committed to maintaining inflation simply “below 2%,” a correct approach aligned with the distinct dynamics of inflation and deflation. Disinflation, and even deflation when healthy and not associated with demand contractions (which rarely occur—deflation, as Raghuram Rajan and Martin Feldstein have noted, is a bogeyman), was fully acceptable. In 2003, the ECB changed its target to aim for inflation “below but close to 2%”. This marked the start of a phase of increased interventionism and greater susceptibility to monetary policy errors. The symmetric approach, introduced in 2021, has only deepened this trend.

The 2000 target

Returning to the pre-2003 approach might be the wiser choice. Allowing monetary policy to be less interventionist—especially when the temptation to act is strong but results are uncertain—would be prudent. Economic research shows that lowering rates and expanding central bank balance sheets can have only limited effects on inflation and growth, while significantly increasing financial imbalances. Limiting monetary policy intervention to situations where the 2% threshold is breached could also give central banks the flexibility to address financial cycles. The last recession triggered by a sudden collapse of the financial cycle’s peak, driven by excessively low interest rates—the Great Recession—has not yet been fully overcome, even though GDP levels have now surpassed their pre-crisis highs in most regions.