The ECB has fallen behind the curve over the last few months as it has stuck to an extremely expansionary stance based on model predictions that inflation would return to slightly below its 2% target within two years. The real problem is thus the nature of this approach, which can justify endless procrastination. In this sense, policy is “model-driven” – and the assertion of the ECB that its normalisation path will be “data-driven” is meaningless unless the ECB abandons the old model with its hardwired low-inflation end point. Besides increasing rates, the ECB should also stop its reinvestment policy of the bonds accumulated so far to start a gradual reduction in its holdings.
This paper was requested by the European Parliament’s Committee on Economic and Monetary Affairs (ECON).