July 25, 2018
Future of euro debate: can the ECB do the heavy lifting?
Our answer to the above question is No. But we would still like to include the contribution by Antoine Levy because it focuses exclusively on the ECB, and because it is quite clever - maybe too clever by half as they say in England. It is also a genuine attempt to solve the problem without breaking the eurozone. And it does not even require treaty change.
His big idea is a subtle shift in the ECB’s inflation targeting regime to something he calls targeted inflation targeting. The idea is to use deviations of a pre-specified economic indicator - domestic producer price levels - to prompt a greater weighting of ECB monetary policy instruments like QE towards the country concerned.
The starting point of his analysis is that the eurozone’s core problem consists of medium-term divergence in wages and price competitiveness between the core and the periphery. He writes that large and persistent gaps in producer prices have led to current account imbalances, and excessive accumulation of public and private debt in the periphery. The regime would all be consistent with the ECB’s goal to target an aggregate inflation rate.
The author lists some technical objections, for example whether producer prices are a good metric. The most obvious objection is that this proposal is simply too late, as QE is being phased out and may never be used again. But his scheme could also apply to ordinary monetary operations albeit in a more subtle way, for example through policies on haircuts.
We think there are several other objections. For example, it places an additional burden on the ECB to fix problems that are political in nature. Will this not overburden the ECB, and set it up for failure?
And while this proposal probably won’t require treaty change, we should not take its legal ramifications for granted. The capital key Levy he wants to usurp is non-discriminatory, which matters a lot in legal arguments. A policy that would discriminate in favour of countries with lower productivity growth could be legally construed as a transfer or even a debt monetisation. In the design of its more recent policies, the ECB has gone to the limits of what it thought it could legally do - with not all that much further room for manoeuvre. We would be surprised if the ECB concluded that it would be able to do what Levy proposes without running into serious legal issues.