Should the European Central Bank change its two percent inflation ceiling?

International Economy, The, Wntr, 2003

The European Central Bank has established an inflation ceiling of two percent. As a result, the central bank in the view of some has been slow to reduce short-term interest rates despite economic sluggishness in many of the larger European economies. Given present conditions, would you keep the targeted ceiling at its current rate? If so, would you have some temporary exceptions such as for special shocks (price of oil, etc.)? To what extent does a lot of the current inflationary pressure relate to structural impediments including labor market rigidities ? Is the two percent ceiling a meaningful benchmark in a situation where, despite short-term inflationary pressures, a different policy mix might lead to improvements in the long run for a stronger economy ? Or is the current arrangement quite appropriate?

No way! Leave it as is!

MILTON FRIEDMAN

Nobel Laureate in Economics, 1976 Senior Research Fellow, Hoover Institution

I vote for leaving the ECB's targeted ceiling as it is. Changing the target will be the first step toward altering completely the role and function of the ECB. A bout of inflation now might temporarily reduce unemployment, but unless labor market rigidities are eliminated, it will soon be time to raise the target once again. A slippery slope indeed. Fine-tuning to a fare-thee-well.

Up it to 3 percent.

EDWIN M. TRUMAN

Senior Fellow Institute for International Economics

The ECB should change its inflation ceiling to 3 percent and adopt inflation targeting with a range of 1-3 percent. The current ECB policy framework has confused the market and policymakers. The ECB has undermined credibility by appropriately, but inelegantly, ignoring the ceiling of 2 percent, defining price stability. Although Euroland desperately needs structural supply-side reforms, its sluggish economic performance is also caused by inadequate demand. Finally, the inflation risk associated with an easier monetary policy is small, and it can easily be reversed; an easier fiscal stance is more difficult to reverse.

Leave it!

HELMUT SCHLESINGER

Former President, Deutsche Bundesbank

My short answer is, "Leave the ECB's target ceiling as it is." My arguments are: It is a ceiling for a medium time horizon, not really a target. In other words, price increases lower than 2 percent annually can be tolerated as well as short-term overshooting. Certainly this is an ambitious target.

One must consider the European Monetary Union is only a creation in the framework of the European Community which is an association of states, not one state; it has not one government but fifteen. And some countries have had a history of high inflation with more than 5 percent inflation in the 1990s, and some have had double-digit rates in the decades before. Therefore, price stability must be a priority target of the ECB.

I feel the critics of the ECB's policy do not really accept differences of monetary policy between the monetary union and on a national basis. They argue as if the euro is an old national currency. But as a currency, it is only four years old and as a common cash, only ten months. It works well in the framework of its task but a fine-tuning of the twelve economies is not its target, and cannot be its target.

Yes, but be precise.

ALLAN H. MELTZER

Allan H. Meltzer University Professor, Carnegie Mellon University, and Visiting Scholar, American Enterprise Institute

Of course, the ECB should keep its policy target unchanged. What point would there be to having a role-like policy and an announced target, if the bank accommodated political pressures and shortcomings as it is now urged to do? While not particularly relevant currently, the ECB, and every other central bank, should be precise about whether its definition of inflation includes onetime shocks to the price level, such as changes in VAT, oil prices, and the productivity level. The big countries in the ECB suffer mainly from mandated structural rigidities, most of them part of the welfare state. People should not expect much from weak European governments. Monetary policy cannot compensate for these real rigidities without inflating. Fortunately, its directors understand that. Perhaps the German, French, and Italian governments will eventually do the same. But don't hold your breath.

Change the ceiling or allow for exceptions.

PETER B. KENEN

Walker Professor of Economics and International Finance, Princeton University

Keep the target, but be aware of the complexity of the situation

CHARLES P. KINDLEBERGER

Ford International Professor of Economics, Emeritus, Massachusetts Institute of Technology

My short answer is no. Nonetheless, I find it somewhat unsatisfactory to make sharp distinctions between monetary policy, managed by the ECB with only one instrument, the repo interest rate, and economic policy more generally, both monetary and fiscal, which calls for attention to economic shocks such as war, labor unrest affecting wages, changes in foreign supply or demand, significant exchange rate fluxuations, changes in membership in the European Union and the Stability and Growth Pact, or in such a key variables as the Common Agricultural Policy. For the ECB to focus on one goal and one tool, ignoring the complexity inherent in events elsewhere in Europe and the world, runs risks.