In the year of the 20th anniversary of the Euro, Philipp Hartmann, Deputy Director General Research of the European Central Bank (ECB), has assessed the ECB´s monetary policy decisions over the past 20 years. In December 2018, together with Frank Smets, he published a working paper, in which he critically analyses the monetary policy measures used by the ECB and their outcome. On 21 February, Hartmann presented his paper in a SAFE Policy Lecture in the House of Finance.
Overall, Hartmann concluded that the ECB fulfilled the mission it was assigned to in monetary policy matters. For him, the measures worked sufficiently and fulfilled the main goal of price stability. However, challenges have emerged through the incomplete European Monetary Union, in particular the imperfect working of prudential banking and fiscal policies. “The ECB has delivered price stability, with major effort to fight disinflationary pressure after the sovereign crisis”, Hartmann said, pointing to the primary objective of price stability of “below, but close to 2 percent”. To this regard, the ECB has been successful: In the last 20 years, the average headline inflation has been 1.7 percent in the euro area. However, fluctuations have been between 4.1 and -0.7 percent, as Hartmann mentioned. In the first ten years from 1999 on, the ECB was close to its objective of price stability. From 2007 on, however, the inflation rate was very volatile as a consequence of the crisis. Facing different challenges, the ECB adapted its monetary policy and broadened its measures.
In the paper, Hartmann and Smets subclassify the first 20 years of the ECB into four cyclical periods. In the first period from January 1999 to June 2003, the Euro was introduced. “Europe is complicated, European monetary policy is complicated”, Hartmann said. As a new institution, the ECB firstly had to quickly establish its credibility and manage the structural change resulting from moving from different national monetary policies to a single one. To this effect, the ECB developed a two-pillar monetary policy strategy, comprising a monetary and an economic pillar. The ECB also focused on communication for transparency and accountability, as Hartmann explained.
In the second period from July 2003 to July 2007, the ECB reviewed its strategy, initiated by Otmar Issing, at that time chief economist of the central bank. The ECB adjusted its inflation aim from “under 2 percent” to “below, but close to 2 percent”. Also, the economic pillar gained importance in the analysis of the right monetary policy. In that period, the economy experienced an upturn. On the other side, imbalances between the euro area countries were growing.
Becoming more similar to other central banks
From August 2007, the third period began until June 2013. It is characterized by a “double-dip recession”, caused by the financial crisis and the sovereign debt crisis, and non-standard monetary policy. In this period, the separation between liquidity operations and interest rate decisions became important. In 2013, as policy rates became increasingly constrained by their lower bound, the ECB started to use “forward guidance” as a communication tool to ensure the adequate monetary policy stance.
The fourth period lasted from July 2013 to June 2018, as Hartmann explained. The economy recovered slowly and there was damage by the sovereign debt crisis, such as very low inflation, risks of deanchoring inflation expectations, and even deflation risks. As a reaction, the ECB implemented negative rates for its deposit facility, used targeted longer-term refinancing operations (TLTROs) and, from 2015 on, an expanded asset purchase program (Quantitative Easing, QE). For example, through undertaking QE, “the ECB has become more similar to other major central banks”, said Hartmann.
Overall, in Hartmann´s view, the ECB has delivered on its price stability mandate, albeit with some difficulty during the recent low-inflation recovery. Based on the analysis of a standard interest rate rule for monetary policy, Hartmann and Smets found, for example, that in 2008 the ECB could have avoided one hike whereas the often discussed two hikes in 2011 were in line with its own macroeconomic projections – and, if anything, “a bit late” relative to the rule. However, Hartmann argued that these two episodes were relatively small compared to the tremendous “headwinds” for monetary policy from Europe’s fiscal and banking problems, which lingered on for much too long. “Its monetary policy strategy and framework served it well, also because it was adapted to new challenges when needed”, Hartmann said. Looking at some of the member states, Hartmann stated that the low-interest rate could have been used better to reduce debt. He mentioned a series of important reforms towards completing European Economic and Monetary Union, such as the European Stability Mechanism and the European Banking Union. “The ECB monetary policy benefits tremendously from a thorough implementation of these reforms and from compliance with their objectives and rules”, he said.
Video of the SAFE Policy Lecture with Philipp Hartmann: The First Twenty Years of the European Central Bank: Monetary Policy
Download: Slides of the presentation