It is an article of faith among central bankers that the decisions they make about how much money to create and what interest rate to charge for it will determine the rate of inflation.
For more than a decade that belief has been undermined by inflation that has remained weak despite trillions of dollars pumped into the world’s biggest economies through quantitative easing programs and ultra-low interest rates. This prompted the top central banks to review how they do business. The European Central Bank joined the Federal Reserve and the Bank of Japan in pursuing an ambitious reset in hopes of reasserting control.
the ECB said in announcing its new framework, echoing language used by Fed officials in announcing their new strategy last year that the euro area economy and the global economy have been undergoing profound structural changes. Declining trend growth, which can be linked to slower productivity growth and demographic factors, and the legacy of the global financial crisis have driven down equilibrium real interest rates. That, in turn, has given the ECB less room to use interest rate policy alone to help boost economic activity.
The aims of the new U.S. and European inflation strategies, and those pursued so far unsuccessfully in Japan, are the same as to get the pace of price increases high enough so inflation-adjusted interest rates can also increase, giving the central banks room to use rate cuts as their main policy tool in times of stress. The new strategy marks a historic shift for the ECB. And that is by acknowledging inflation and may need to exceed 2% at some point, wrote Andrew Kenningham, chief Europe economist for Capital Economics.
