Low inflation and defunct monetary policy risk threatening the European Central Bank’s (ECB) reputation as an effective organisation, according to one of its top economists, Peter Praet, who sits on the ECB’s executive board alongside its president, Mario Draghi.
Praet warned that if the ECB fails in its efforts to save Europe from a period of sustained deflation, it will undermine the stability of the economic recovery and could result in a sustained crisis of confidence in policymakers’ abilities to guide the economy.
“Allowing inflation to re-anchor downwards comes with a high risk of credibility losses for the central bank … especially when the expectation is not being met,” Praet told an audience in Rome this morning.
The ECB is tasked with ensuring inflation – the rate at which prices are rising across the economy – runs at close to two per cent a year. The last time it was at this level was in January 2013, having been below one per cent since since October 2013 and currently running at minus 0.1 per cent.
Low – or negative – inflation is a concern for policymakers as it can sap consumer confidence, knock demand, increase the cost of servicing debt and generally hit growth.
In response, the ECB has dipped into an unprecedented set of policy tools. It is buying up government and company debt through its quantitative easing programme and is also charging the banks which store cash at the ECB an annualised rate of minus 0.4 per cent.
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Praet defended the Bank’s assault on low inflation, pointing to “decades of experience [that] have confirmed the importance of price stability for macroeconomic stability and sustained economic growth”.
“In a fragile post-crisis situation where monetary policy is sustaining the recovery, any perception that the central bank is adopting a greater tolerance towards a future regime of lower inflation can have very negative effects,” he added.
Firing a warning shot to those who claim the ECB is out of ammunition, Praet said, “this is why we have reacted so forcefully to secure our objective – and will continue to do so in the future if necessary”.