European Central Financial institution Tweaks Technique to Battle Inflation

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The European Central Bank said Thursday it would adjust the guard rails it uses to set monetary policy to give it more leeway to take crisis action even if inflation rises above its official target. The bank also announced that it would use its clout in the bond markets to combat climate change.

After completing an 18-month review of its strategy, the Governing Council said on Thursday that it would keep inflation close to, and no longer below, 2 percent since 2003. Instead, the bank would simply 2. aim for percent and be ready to “accept a transition period in which inflation is moderately above target”.

“Two percent is not an upper limit,” said the President of the European Central Bank, Christine Lagarde, on Thursday at a press conference.

The seemingly minor change gives the bank scope to continue pumping credit into the eurozone economy even if annual inflation goes above target, as long as policymakers believe the jump is temporary.

This scenario could happen soon. Inflation in the eurozone has hovered around 2 percent in the past few months and could rise higher if economies reopen and shortages of required products such as semiconductors become more acute. According to the previous strategy, the central bank would be obliged to raise interest rates or take other measures to dampen the economy, even if the crisis was not over yet.

According to the law, price control is a top priority in the 19 eurozone countries, so any adjustment to their inflationary approach will have far-reaching implications for the interest rates that businesses and consumers pay on credit, as well as employment and economic growth.

The bank also announced that it would take climate change into account when buying corporate bonds as part of its stimulus measures. The bond purchases made with newly created money are one of the bank’s primary tools to stimulate borrowing and economic growth. In the future, however, the European Central Bank will give preference to companies that have made serious efforts to reduce the amount of carbon dioxide they produce.

In practice, the central bank has already produced ample evidence that it was ready to change its own rules to tackle the pandemic or debt crisis that nearly destroyed the euro a decade ago.

“The more modern and clearer strategy will make it easier for the ECB to communicate with the markets and the public,” said Holger Schmieding, chief economist at Berenberg Bank, in a customer announcement. “It embodies the flexibility that the ECB has granted itself anyway.”

The European Central Bank’s new approach is sure to provoke criticism from countries like Germany, where fear of inflation is deeply rooted. Jens Weidmann, member of the Governing Council and President of the Deutsche Bundesbank, called on the European Central Bank to withdraw its stimulus packages so that inflation does not get out of hand. He also said that climate change is not a matter for central banks. But Ms. Lagarde said the members unanimously approved the new strategy.

The Governing Council defended its decision to make climate change the task of central banks, saying it was relevant to “inflation, output, employment, interest rates, investment and productivity; financial stability; and the transmission of monetary policy. “