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Shadow ECB

Council warns that forward guidance is compromised by neglect of deflation danger

VonNorbert Häring

At the meeting of the Shadow ECB Council on 27 March, 2014, five of 13 voting members advocated a cut in at least one policy rate. One member advocated a hike.

Under construction: The new headquarter of the European Central Bank (ECB) in Frankfurt am Main ap

Under construction: The new headquarter of the European Central Bank (ECB) in Frankfurt am Main

FrankfurtThere was broad consensus on the Shadow Council that the undershoot of the ECB’s inflation target should be of greater concern to the central bank than its public communication suggests.

Members expect medium-term inflation undershoot

All members who provide forecasts expect a subpar recovery and sub-target inflation for the next two years. On average they forecast GDP-growth of 1.0 per cent this year and 1.3 per cent in 2015. These forecasts are 0.2 percentage points below the latest ECB projections Shadow Council members forecast inflation rates of 1.0 per cent this year and 1.2 per cent next year, which would mean inflation significantly below the ECB’s inflation target of “close to but below 2 per cent” for three years in a row. These forecasts are marginally lower than the January-forecasts and roughly in line with the latest ECB projections.

 The geopolitical turbulences around Ukraine and the strong external value of the Euro were cited as key risks to the nascent economic upswing.

Shadow Council macroeconomic forecasts

(Forecast means in %, previous forecasts in brackets)

20131.4-0.4 (-0,4)
20141.0 (1,1)1.0 (0,9)
20151.2 (1.3)1.3 (1.2)


M. Annunziata, M. Balmaseda; E. Bartsch; A. Bosomworth; S. Broyer; J. Cailloux; J. Callow; E. Chaney, M. Diron, J. Krämer, E. Nielsen, J.-M. Six


ECB is criticized for downplaying risk of deflation

There was broad consensus on the Shadow Council that the low and declining inflation rate in the euro area as a whole and negative rates in some individual countries pose a serious problem; more serious than ECB representatives would admit. I t was stressed by many that low inflation goes together with low growth of nominal incomes and turnover, exacerbating solvency problems of highly indebted consumers and companies and thus leading to insolvencies and more non-performing loans. Members criticized the ECB for downplaying the significance of disinflation and potential deflation. They argued that this undermined the effectiveness of the ECB’s forward guidance, aimed at lowering long-term interest-rates.

There was a consensus that instead of stressing “well-anchored inflation expectations”, the ECB should act decisively to counter deflation risks and the consequences of below-target inflation.

Many members consider the euro’s exchange rate too high in light of the weak state of the euro area economy and the continued downward drift of inflation and inflation expectations. They consider this an argument for action by the ECB, given that other central banks pursued a more expansionary monetary policy and thus might push down their currencies even further against the euro, if the ECB sat on its hands.

Support for a rate cut and negative deposit rate increasing

While there was a general sense that the interest rate channel has lost most of its effectiveness, there was a sizeable minority of members who advocated a cut in policy rates. Four members voted for a cut of the main refinancing rate to 0.1 or 0.0 percent from the current 0.25 percent. One member suggested cutting only the deposit rate into negative territory, while leaving the main refinancing rate unchanged. Members who advocated a rate cut expected this to depress the euro exchange rate, something they considered helpful in supporting the recovery.

A slight majority advocated unchanged rates, either because they considered interest-rate changes at a level near zero percent ineffective, or because they favoured keeping some of the powder dry in order to be able to react to further unfavourable developments. One member argued in favour of an interest rate hike, because he is concerned that an extended period of very low interest rates may create asset price bubbles.

Asset purchases and other measures discussed

Many members suggested that the ECB develop concrete plans for the purchase private sector assets government securities to bring more money into circulation and to compensate for very weak lending activity of banks. A few members pushed for announcing such a program immediately. One member suggested purchases of US-assets to combine the creation of money with increasing demand for dollars and thus depressing the euro exchange rate. While several members agreed with the argument in principle, they considered the proposal unrealistic, since the US-Treasury would not countenance such a move by the ECB, in their judgement.

Fewer members focused their suggestions instead on the provision of more and longer-term credit facilities to banks.

Members’ individual votes:
MemberAffiliationRate recommendation
José AlzolaThe Observatory Groupunchanged
Marco AnnunziataGeneral ElectricUnchanged***
Manuel BalmasedaCEMEXn.a.
Elga BartschMorgan Stanleycut 0.15%
Andrew BosomworthPimcounchanged
Sylvain BroyerNatixisunchanged
Jacques CaillouxNomuraunchanged
Julian CallowCatalyst Economicscut 0.15%
Eric ChaneyAxacut 0.15%
Janet HenryHSBCcut 0.15%
Merijn KnibbeWageningen Universitycut 0.25%
Jörg KrämerCommerzbankhike 0,25%
Erik NielsenUnicreditn.a.
Jean-Michel SixStandard & Poor'sunchanged
Richard WernerUniversity Southamptonunchanged
*** Member voted for cut in deposit rate only

Frankfurt, 28 March, 2014

Norbert Häring

Non-voting Chairman of the Shadow ECB Council

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