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The core problem of the Ecb’s dangerous asymmetry


The ECB has once again failed to take action to boost the European economy, either by cutting rates (from their already very low level of 0.25%) or, more effectively, by adopting one or more direct measures to inject liquidity into the economy. This is despite the fact that inflation, at 0.8%, is well below target of close to but below 2%. And it is despite the fact that the Central Bank itself does not see inflation returning to target across its whole forecasting horizon. It is now predicting a rate of 1.7% to be reached by the very end of 2016! HICP inflation fell below 2% in January 2013. In other words, if the ECB is right, by the end of 2016 inflation will have been consistently below 2% for four whole years.


How this can be squared with the ECB’s mandate is a complete mystery to me. Its primary responsibility, to keep inflation close to the target ‘in the medium run’, clearly requires it in my view to take expansionary measures. The current silence of those who questioned the legality of the central bank’s OMT programme before the German Constiutional Court is truly deafening.


I have heard a number of commentators pose the rhetorical question, whether the ECB would not be raising rates if inflation were as far above its target as it is now below. In the jargon: does the ECB have an asymmetric reaction function? Three remarks.


The first is that, while this is a good question, it stacks the cards rather in favour of the ECB, in the sense that most serious economists (and organisations like the IMF) are agreed that deflation (falling prices) is much more worrying than somewhat above-target inflation. All the more so when there is a lot of debt around that economic agents are trying to pay down. But let the cards be so stacked! What, second, does past evidence suggest that the ECB actually does when inflation is above 3%?

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