Biagio Bossone and Stefano Sylos Labini look how ECB could have better managed the crisis.
They pick a note from Franco Modgiliani and other scholars which argued for a broad based ECB:
The ECB has not only failed to provide stimulus to the Eurozone economy when needed, it has allowed it to slip into a low inflation trap (Kang et el. 2016). This is in sharp contrast to the US Fed, which has served its country well by taking an aggressive stance against the Crisis. The depth of the Eurozone recession is not the making of the ECB only, and the responsibility for it must primarily be ascribed to the destructive policy orientation of the EZ member governments. Moreover, the ECB response to the Crisis is a reflection of the original sin of the Eurozone, its faulty architecture.
Yet someone had foretold all this, warning EZ policymakers of the consequences that a misguided policy framework would produce. In 1998, Franco Modigliani and other distinguished scholars issued a ‘manifesto’ that was aimed to challenge the “pernicious orthodoxy that has gripped Europe’s policy makers” whereby only a limited number of supply policies are to be devoted to fighting unemployment, while demand policies (in particular monetary policy) must be exclusively assigned to controlling inflation (Modigliani et al. 1998).1
The manifesto outlined a set of demand-side and supply-side policy proposals that, together, were intended to right the unemployment bias inherent in the policy approach of the then nascent Eurozone. There is no space here to recall the proposed measures put forward, which would sound innovative and appropriate still to date, especially in so far as they would have inspired a truly European vision of economic policy. We only focus on what the manifesto had to say on the role of the ECB, and the implications that can be drawn from the experience since then.
There were three issues:
Modigliani and colleagues argued three basic points in this regard.
- First, making price stability the overriding ECB target was much like using all the military might
- Second, monetary policy has very limited control over the level of prices, at least in the short run
- The third reason for giving the ECB a central role in promoting investment was that with the shift to the single monetary policy, the ECB was to become the only institution within the monetary union with substantial power to influence investment.
Way out? Dual mandate like Fed:
What should be done? At a minimum, a wide debate should be opened on the adequacy of the EZ architecture. Without any attempt to identify a complete agenda, at least three sets of critical issues should be raised on the ECB policy framework.
- Dual mandate
The Crisis has shown that considering Modigliani’s proposal to broaden the interpretation of the ECB statute is a largely overdue issue (Saraceno 2013). Establishing price stability and low unemployment as equal-status macroeconomic policy objectives would crystallise one of the major lessons from the Crisis: demand-side policies do affect employment and wages. Introducing a dual mandate would thrust upon the ECB the responsibility to mediate between these two overarching social objectives in normal times, while it would steer monetary policy to address unemployment problems in times of crisis.
- Nominal GDP targeting
An alternative option to consider is for the ECB to targeting nominal GDP (Sumner 2014). Hitting the target avoids recessions in nominal terms by definition, and dampens recessions in real terms by supporting aggregate demand. More generally, nominal GDP targeting reduces positive and negative GDP fluctuations; in recessions, it focuses on returning the economy to a normal path; in an inflationary environment, it provides a gradual path to stability.
- Symmetric inflation target
As an inferior alternative, the ECB inflation mandate could be set to be strictly symmetrical. Like in the Bank of England’s case, inflation below 2% would be judged to be just as bad as inflation above 2%, and if the target is missed by more than 1 percentage point on either side, the ECB chairman would be required to write an open letter to the European parliament explaining the reasons of the deviation and identifying corrective measures.
In the US, they are debating to become more like ECB and ECB wants to be more like Fed..