Home > ECB, EMU Crisis, Monetary Policy > ECB: One Size Fits None

ECB: One Size Fits None

Eurostat just released its flash estimate for inflation in the Eurozone: 0.5% headline, and 0.8% core. We now await comments from ECB officials, ahead of next Thursday’s meeting, saying that everything is under control.

Just this morning, Wolfgang Münchau in the Financial Times rightly said that EU central bankers should talk less and act more. Münchau also argues that quantitative easing is the only option. A bold one, I would add in light of todays’ deflation inflation data. Just a few months ago, in September 2013, Bruegel estimated the ECB interest rate to be broadly in line with Eurozone average macroeconomic conditions (though, interestingly, they also highlighted that it was unfit to most countries taken individually).

In just a few months, things changed drastically. While unemployment remained more or less constant since last July, inflation kept decelerating until today’s very worrisome levels. I very quickly extended the Bruegel exercise to encompass the latest data (they stopped at July 2013). I computed the target rate as they do as


(if you don’t like the choice of parameters, go ask the Bruegel guys. I have no problem with these). The computation gives the following:


Using headline inflation, as the ECB often claims to be doing, would of course give even lower target rates. As official data on unemployment stop at January 2014, the two last points are computed with alternative hypotheses of unemployment: either at its January rate (12.6%) or at the average 2013 rate (12%). But these are just details…

So, in addition to being unfit for individual countries, the ECB stance is now unfit to the Eurozone as a whole. And of course, a negative target rate can only mean, as Münchau forcefully argues, that the ECB needs to get its act together and put together a credible and significant quantitative easing program.

Two more remarks:

  • A minor one (back of  the envelope) remark is that given a core inflation level of 0.8%, the current ECB rate of 0.25%, is compatible with an unemployment gap of 1.95%. Meaning that the current ECB rate would be appropriate if natural/structural unemployment was 10.65% (for the calculation above I took the value of 9.1% from the OECD), or if current unemployment was 11.5%.
  • The second, somewhat related but more important to my sense, is that it is hard to accept as “natural” an unemployment rate of 9-10%. If the target unemployment rate were at 6-7%, everything we read and discuss on the ECB excessively restrictive stance would be significantly more appropriate. And if the problem is too low potential growth, well then let’s find a way to increase it
  1. March 31, 2014 at 4:34 pm

    What about repeating your exercise with data for Germany? In the past, I think I have seen Taylor’s rule estimates fitting much better the ECB’s interest rate policy when German data were used in lieu of the Eurozone ones….

    • April 1, 2014 at 1:47 pm

      To be done. It is what the Bruegel researchers did last September

  2. Patrick VB
    April 1, 2014 at 1:53 pm

    Hello Francesco, you show that the current ECB MRO rate would be more or less consistent with a Nairu of about 10.6%. Currently, the EU Commission officially estimates the 2013 EU-17 Nairu at 10.8%. And, the Commission is convinced that this number is meaningful…

  3. Patrick VB
    April 1, 2014 at 2:03 pm

    Francesco, do you know if the Bruegel specification is for a real rate?… A 1% long-run or equilibrium rate as implied by their specification seems very low to me, or then only compatible with an equally (worryingly) low estimate of long-run output growth…

    • Patrick VB
      April 1, 2014 at 3:10 pm

      Upon reflection, no, this implies a real output growth rate of about 1.5%, which would seem to be about right. Not brilliant, but still in line with recent trends.

      • April 1, 2014 at 3:22 pm

        Yes, they seem to have a somewhat pessimistic long run rate in their model. Pessimistic but probably more realistic than the 3% usually taken by this type of exercises

  4. Patrick VB
    April 1, 2014 at 4:08 pm

    Note that Bruegel uses a variant of the Taylor rule in which unemployment appears explicitly with a unit coefficient and where there is no explicit inflation gap. The traditional Taylor rule would postulate a coefficient of 0.5 on the unemployment gap and a coefficient of 1.5 on the inflation gap. The traditional Taylor rule, with 0.5% HICP inflation, an inflation objective of 2%, an unemployment rate of 12% and a Nairu of 10%, leads to an MRO rate of 0.25%, which corresponds to the effective ECB MRO rate since November 2013.

    • Patrick VB
      April 1, 2014 at 4:11 pm

      Using this more traditional Taylor rule, and a Nairu estimate of 7% (which I view as a more realistic estimate on non-cyclical, long-run unemployment than the Commission’s estimate), we find an ECB MRO rate of -1.25%.

      • April 1, 2014 at 4:18 pm

        Be careful though, that the original Taylor rule has the output gap, not the unemployment gap, as a second term. But I take your point

  5. April 9, 2014 at 9:35 am

    Your post is similar to the Short Side of Long post The Fed’s Goal To Improve Employment By Printing Money Has Failed! This remains the worst/weakest recovery ever; the real economy has grown very little. And it is similar to the Confounded Interest posts Low Paying Services Jobs Lead Recovery.

    Jesus Christ consistently acts in dispensation, a concept developed by the Apostle Paul in Ephesians 1:10. The idea is that He acts in economic oversight to mature every age and paradigm, bringing it its completion, much like a ship’s captain completes the ship’s manifest, before setting sail on a new journey.

    Christ fully developed liberalism, meaning freedom from the state, by creating the investor through the repeal of the Glass Steagall Act, and then perfecting it as the age and paradigm of credit and investment choice, on April 4, 2014, by driving World Stocks, VT, Nation Investment, EFA, Global Financials, IXG, and Dividends Excluding Financials, DTN, lower from their March 2014 highs. On Monday April 7, he actively birthed authoritarianism by unwinding liberalism’s currency carry trades and debt trades, and is creating the age and paradigm of debt servitude and the debt serf.

    The Fed’s Goal, as well as the ECB’s Goal has NEVER been to improve employment and global growth. Though Federal Reserve QEs, ECB LTROs and OMT, PBOC Monetary Injections, and other similar world central bank monetary actions, credit was made widely available to investors, such as day traders, real estate investors, students, and even clients of liberal governments, such as those living in Greece Socialism, and those in the US living on welfare, TANF, SSI/SSD, and Section 8 Housing, all through the speculative leveraged investment community, creating a spectacular moral hazard based prosperity enjoyed by only a relative few, in particular those with fiat wealth and those earning executive incomes, as they profited from investment in currency trades in Ireland, EIRL, Greece, GREK, Germany, GERJ, The UK, EWUS, The Gulf, GULF, Egypt, EGPT, Denmark, EDEN, the US, IWM, Eurozone Small Cap Dividend, DFE, and New Zealand, ENZL, as is seen in the combined ongoing Yahoo Finance Chart, as well as debt trades such as Real Estate Investment Company, Blackstone, BX.

    Since 1998, the focus of Jesus Christ has been on perfecting liberalism’s moral hazard based prosperity, through the Banker and Democratic Nation State Regime, and its three dynamos of creditism, corporatism, and globalism.

    Having achieved Peak Liberalism, meaning ultimate freedom from the state, on April 4, 2014 with Peak World Stocks, VT, Peak Nation Investment, EFA, Peak Wall Street, IXG, and Dividend Investing, DTN, He is now pivoting the world into authoritarianism, via the singular dynamo of regionalism, to achieve authoritarianism’s debt servitude based austerity, through the Beast Regime and Regional Economic Government and Totalitarian Collectivism, seen in Revelation 13:1-4, where liberalism’s fiat wealth and fiat money will be utterly pulverized as is seen in Daniel 7:7.

    The imminent ECB decision of Thursday, April 10, 2014, will certainly be an effecting working of the dispensation of Jesus Christ, as is seen in Ephesians 1:10, for the completion of authoritarianism as the age of debt servitude.

  1. April 4, 2014 at 6:50 pm
  2. April 5, 2014 at 3:33 pm
  3. April 5, 2014 at 4:22 pm
  4. April 5, 2014 at 5:33 pm
  5. April 7, 2014 at 8:49 am
  6. April 12, 2014 at 9:32 pm
  7. May 3, 2014 at 1:41 am
  8. June 1, 2014 at 11:30 am

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