The last time the European Central Bank conducted a review of its monetary policy strategy the euro was only four years old, no country had ever experienced negative interest rates and Christine Lagarde was running a US law firm.
Now Ms Lagarde, who has been in charge of the ECB for just over a month, is preparing to launch the central bank’s second strategic review in its 20-year history. It is set to trigger a series of bruising debates on some of the most divisive issues in central banking, from negative rates to climate change.
The Frenchwoman, who will face questions about the review at her debut press conference on Thursday, aims to use the process to put her stamp on the central bank and to address the divisions that opened up under her predecessor as president, Mario Draghi.
Most central banks carry out strategic reviews regularly; the ECB is unusual in having waited since 2003. The US Federal Reserve is in the middle of such an exercise, as is the Bank of Canada, while the UK Treasury’s review of the Bank of England is a year overdue.
The ECB’s governing council is yet to formally discuss the planned review and it is likely to be the new year before it has time to approve it. Ms Lagarde told the European Parliament last week that it “will be guided by two principles: thorough analysis and an open mind”, while adding that “every stone will have to be turned and every option will have to be examined”.
The Financial Times has spoken to several senior officials involved in preparing the review and identified three key areas where debate is expected to be most intense.
The 16-year period since the last review was dominated by the 2008 financial crisis and the eurozone’s subsequent debt crisis, which led to its embrace of unconventional monetary policies — including cutting the deposit rate into negative territory and purchasing more than €2.6tn of bonds.
Despite the vast amounts of cheap money injected into the economy the ECB has struggled to achieve its inflation objective of below but close to 2 per cent.
The review is likely to require more research into the causes of low inflation to examine whether this is a short-term cyclical phenomenon or the result of more long-term structural factors such as digitisation, globalisation or demographics.
The assessment of how well its policies have worked is likely to prove contentious; some policymakers are likely to call on the ECB to study the negative side-effects and reconsider their use.
“In an extreme case, if a policy has become detrimental, reversing it should be a net positive for the economy,” said Mark Wall, chief economist at Deutsche Bank.
One of the most important questions for the review is how the ECB defines its main mandate of achieving price stability. In 2003 it tweaked its medium-term inflation objective from between zero and 2 per cent to a narrower objective of “below but close to 2 per cent” to guard against the risk of deflation.
Klaas Knot, president of the Dutch central bank and ECB governing council member, argued in a speech last week that the central bank should accept it could not achieve its inflation aim and change it into a band — such as between 1.5 and 2.5 per cent — or allow more time to achieve it.
“Both approaches would buy us time and flexibility in responding to forces we simply cannot control,” he said.
Philip Lane, ECB chief economist, said recently the objective should be symmetrical — indicating it would be as worried about inflation being too low as being too high. This principle was adopted by Mr Draghi shortly before he stepped down as ECB president in October.
A more aggressive way to tackle persistently low inflation, which is being considered by the US Fed, is a “make-up strategy” that commits to overshooting a target for a period to compensate for any time spent below it.
Some ECB-watchers, such as former IMF chief economist Olivier Blanchard, have even suggested boosting investors’ expectations of price growth by raising the inflation objective to 4 per cent.
All of these proposals are likely to face some opposition, however.
Danae Kyriakopoulou, chief economist at think-tank OMFIF, said the central bank could instead place greater emphasis on core inflation, which excludes more volatile fuel and food prices and should be more predictable.
Others have called for the cost of owner-occupied housing to be included in inflation calculations — as Germany and the US already do — as this may better reflect most people’s cost of living. But some central bankers are wary of linking monetary policy decisions more closely to changes in asset prices.
The review may also look at other issues including climate change, cryptocurrencies and inequality. But these could be carved out into a second, more forward-looking process once the core debate over its main objectives and toolkit is settled.
Ms Lagarde has made it clear she believes the central bank should explore “how we can be effective in participating in the fight against climate change”, although she acknowledges it is not the ECB’s primary goal. However several central bankers have warned that any initiative must not interfere with the ECB’s main price stability goal and that it should mostly leave this issue to politicians and credit rating agencies.
The danger for the ECB, said Ms Kyriakopoulou, was that Ms Lagarde’s push to address wider areas of public concern — like climate change or inequality — could leave it more exposed to political criticism.
“If the ECB is seen as veering into areas that are not its primary responsibility it could have an impact on its independence,” she said.