European Central Bank: What the new inflation target means

More inflation and more climate protection: The European Central Bank has decided on a new monetary policy course. In addition, it now tolerates inflation that is temporarily above the target.

The European Central Bank (ECB) has softened its goal of accepting currency devaluation of no more than two percent. As expected, the central bank agreed on a new inflation target of exactly two percent at its meeting today. At first glance, this is only slightly higher than the previously estimated “below, but close to two percent”. However, the new target allows the central bank to leave interest rates unchanged in the future even if inflation occasionally “moderately overshoots the target value”, as is currently the case. In Germany, the price increase was recently at 2.3 percent.

According to experts, it was precisely this question of how the central bank should react to excess inflation in the future that was controversially discussed in the Monetary Policy Council until recently. Apparently a look at the USA helped. There the Federal Reserve (Fed) uses elements of “average inflation targeting”. This means that after a period with inflation below its inflation target, the central bank will tolerate overshooting for a period in order to achieve the target inflation rate on average.

Weidmann was skeptical at first – experts too

Bundesbank President Jens Weidmann had spoken out against such a strategy in advance. Because holding still when inflation exceeds the target of two percent in the medium term without the central bank intervening could be misunderstood. However, he agreed to today’s decision by the Governing Council. It was achieved unanimously, said ECB President Christine Lagarde in the afternoon.

In fact, with the new inflation target of two percent, the ECB is giving itself more leeway to adhere to its zero interest rate policy – regardless of the development of consumer prices. “It can therefore be assumed that monetary policy will remain loose for the time being,” says Ralf Umlauf, an economist at Helaba. The banking association also warns: “The economy and savers in the euro area will unfortunately continue to have to adjust to negative interest rates for the foreseeable future.”

Professor Friedrich Heinemann from the Mannheim economic institute ZEW also reacts skeptically. He believes that the raised inflation target will pave the way for a higher rate of inflation. “Because inflation below two percent is now just as bad as inflation above two percent, it will be even easier for the Governing Council to justify continued extremely loose monetary policy and bond purchases in the coming years,” said the economist. The explicit reference that a moderate exceeding of the target may have to be accepted for a transition phase further weakens the binding nature of the target as an upper limit, according to Heinemann.

Housing costs and climate protection

On the other hand, the decision of the central bank to include housing costs in the calculation of inflation is unanimously welcomed. However, this is a “multi-year project,” declared the central bank. In the meantime, the ECB will include preliminary estimates of housing costs for people who own their own home in its inflation calculation.

As Lagarde has long called for, the ECB wants to take climate protection into account more in its monetary policy in the future. To this end, “a comprehensive action plan with an ambitious roadmap for further inclusion of climate protection considerations” has been resolved in the monetary policy framework, the central bank announced.

How exactly this goal should be implemented, however, remains open. The central bank has the greatest leeway to implement an ecologically friendly monetary policy with its bond purchase program. In the case of corporate bonds, for example, it has begun to consider “relevant risks of climate change” in its assessment procedures for asset purchases.