SINTRA, Portugal (Reuters Breakingviews) - The European Central Bank’s annual gathering in Portugal is this year as much a celebration of its outgoing president, Mario Draghi, as a deep dive into the euro’s first 20 years. The Italian leaves his as-yet-unnamed successor one big unfinished job: pushing up stubbornly low inflation. But he is helping as much as he can before he goes.
Draghi, whose term finishes at the end of October, said on Tuesday that monetary policy might need to be eased again if inflation failed to accelerate. It would have been easy enough for the man credited with saving the euro to rest on his laurels for the last few months of his tenure. After all, many of the central bankers and private-sector economists gathered in the luxury resort town of Sintra were convinced he would be remembered alongside the founders of the single currency. Draghi’s hint in some ways ties the hands of his successor. But it also sends a clear message to households, companies and investors that the ECB will keep doing its utmost to lift inflation to its target of just under 2% even after he has left.
That’s important because one of his potential successors, German central bank chief Jens Weidmann, who was also at the Sintra conference, has in the past criticised the ECB’s ultra-loose monetary policy and is viewed by investors as one of its most hawkish rate-setters. But regardless of who replaces Draghi, the job of boosting inflation will be a tough one.
True, the next ECB boss will inherit a wider range of tools than Draghi did, including massive asset purchases which are now a mainstream policy lever. But such innovations have yet to boost either the euro zone inflation rate, which fell to 1.2% in May, or market measures of long-term price expectations. One such gauge, the five-year/five-year forward, has fallen to record lows below 1.2%.
There are several reasons why Draghi missed the inflation target despite his best efforts. One is that fiscal policy has not always pulled in the same direction as monetary policy during his eight-year tenure. This was the case during the euro zone crisis when governments cut back on spending despite an economic slowdown. Surging borrowing costs meant their priority was to restore investors’ confidence.
The ECB boss told the packed conference room that rate-setters would do their job regardless of whether governments loosened budgets. But he and other speakers made it clear on Tuesday that euro zone price pressures would appear more quickly, and with fewer side-effects, if overall euro zone fiscal policy were more accommodative. One idea that kept cropping up was a large joint fund to allow the bloc’s 19 members to absorb economic shocks, a so-called fiscal capacity.
Resistance from the likes of Germany and the Netherlands means, however, that there’s little chance in the foreseeable future of a fund being set up with the firepower to meet these aspirations. Granted, a public backlash against austerity in many countries has made politicians more willing to loosen the purse strings. And if low inflation means that interest rates also stay low for a protracted period, a bit of extra public debt is less likely to be a problem.
But the countries who can least afford it, notably Italy whose debt is already equivalent to roughly 130% of GDP, may be the ones who are readiest to splurge. Nor will spending always be wisely directed towards, say, investment in infrastructure. And the more that central banks do, the more governments will rely on them to do the heavy lifting.
In Europe, this is more likely to take the form of foot-dragging than the sort of unabashed political pressure seen in the United States. U.S. President Donald Trump, who has attacked Federal Reserve Chairman Jerome Powell in the past for raising interest rates, even turned on Draghi on Twitter on Tuesday, accusing the ECB chief of trying to weaken the euro to gain an unfair advantage in trade.
On the sidelines of the Sintra conference, these comments mostly elicited mirth and sympathy for Powell, who is often in Trump’s firing line. It also prompted some to wonder whether central bankers will be increasingly vulnerable to such pressure if they take on more responsibilities and deploy tools that are more and more unconventional. Yet, rate-setters acknowledge they remain the first line of defence if an economic slowdown turns into something more serious. Paradoxically, this makes it easier for governments to avoid taking tough decisions. Draghi’s latest policy hints show that he, and his successor are destined to keep stepping in to make up for others’ failings.
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