The ECB and the fight against inflation, orthodoxy or ‘obsession’?

The substantial difference that animates the dialectic between hawks and doves

There BCE fight againstinflation too high, or too low, because keeping it as close as possible to 2% is the main objective of his mandate. President Christine Lagarde recalled this once again today in front of the European Parliament. At the ECB “we are fully committed to fighting inflation and are determined to achieve a timely return to our medium-term objective of 2%”.

These words are a mantra that any president of the European Central Bank is required to repeat, by statute. It’s a matter of orthodoxy with respect to the laws of monetary policy because, as Lagarde herself adds immediately afterwards, “this commitment to price stability contributes to economic growth and employment in the medium term and, therefore, to the reduction of inequalities”.

The foundation of this reasoning is the axiom that links inflation control, economic growth and employment. However, the significant variable is the ‘medium term’. Because instead, in the short term, there may be phases in which the good intentions of monetary policy do not coincide with its effective transmission to the real economy. These are the phases in which the fight against excessively high inflation, through a restrictive policy and rate hikes, ends up compromising support for growth.

Tight monetary policy intervenes when faced with excessive and prolonged inflation. An excessively pronounced increase in prices, in fact, compresses the purchasing power of households and weighs on businesses. But excessive monetary tightening, in addition to curbing inflation, can weigh on the performance of GDP, triggering a negative spiral. On the contrary, the expansionary monetary policy aims to boost consumption and investment. But if it goes too far, it can drive up inflation in the medium term, effectively going against its main objective, which remains price stability.

For this reason, the correct balance between the two opposing thrusts is continually discussed. As long as one remains in orthodoxy the nuances between the different positions are reconcilable, when instead orthodoxy becomes ‘obsession’, the rift between hawks and doves is consummated, which then often coincides with the division on two fronts between the strongest and most rigorous countries and those most exposed to high debt and the moods of the markets. (From Fabio Insenga)