Hennecke, Pe e
A icle
The ECB's New Mone a y Policy S a egy: Is he Tempo a y
Accep ance o O e shoo ing In la ion Jus i ied?
In e economics
Sugges ed Ci a ion: Hennecke, Pe e (2021) : The ECB's New Mone a y Policy S a egy: Is he
Tempo a y Accep ance o O e shoo ing In la ion Jus i ied?, In e economics, ISSN 1613-964X,
Sp inge , Heidelbe g, Vol. 56, Iss. 5, pp. 295-298,
h ps://doi.o g/10.1007/s10272-021-1002-9
This Ve sion is a ailable a :
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ZBW – Leibniz In o ma ion Cen e o Economics 295
In la ion
DOI: 10.1007/s10272-021-1002-9
Pe e Hennecke, FOM Uni e si y o Applied Sci-
ences o Economics and Managemen , Hambu g,
Ge many.
Pe e Hennecke*
The ECB’s New Mone a y Policy S a egy
Is he Tempo a y Accep ance o O e shoo ing Infl a ion Jus ifi ed?
The ECB upda ed i s mone a y policy s a egy o he i s ime in 18 yea s in July 2021.
The ein, he ECB announced ha i is willing o accep a ansi o y pe iod o mode a e
in l a ion o e shoo in i s e o s o push in l a ion upwa ds a e a long pe iod o unde shoo ing
i s a ge . This s udy explo es whe he such an o e shoo can be economically jus i i ed
employing a simple Phillips cu e model. The esul s poin o he conclusion ha he a e age
in l a ion a e o e he business cycle consolida ed abou one pe cen age poin below he
ECB’s a ge a e. A empo a y asymme y o he ECB’s mone a y s a egy seems he e o e
jus i i ed o ealign in l a ion and in l a ion expec a ions wi h he a ge a e.
To main ain he symme y o i s infl a ion a ge , he
Go e ning Council ecognises he impo ance o ak-
ing in o accoun he implica ions o he e ec i e lowe
bound. In pa icula , when he economy is close o he
lowe bound, his equi es especially o ce ul o pe sis-
en mone a y policy measu es o a oid nega i e de-
ia ions om he infl a ion a ge becoming en enched.
This may also imply a ansi o y pe iod in which infl a-
ion is mode a ely abo e a ge . (ECB, 2021a)
The Eu opean Cen al Bank (ECB) upda ed i s mone a y
policy s a egy o he fi s ime in 18 yea s in July 2021.
Mos no ably, i s infl a ion a ge was se o exac ly 2%
annual inc ease o he Ha monised Index o Consume
P ices (HICP) o e he medium un ins ead o he o me
defi ni ion o “below bu close o 2%”.1 While his change
appea s o be o a me ely seman ic na u e, he ECB u -
he announced ha i is willing o accep a ansi o y pe-
© The Au ho (s) 2021. Open Access: This a icle is dis ibu ed unde he
e ms o he C ea i e Commons A ibu ion 4.0 In e na ional License
(h ps://c ea i ecommons.o g/licenses/by/4.0/).
Open Access unding p o ided by ZBW – Leibniz In o ma ion Cen e
o Economics.
* Da a used in his a icle a e a ailable a h ps://jou nalda a.zbw.eu/
jou nals/abou /in e economics.
1 Beside he adjus men s o i s infl a ion a ge , he ECB announced an
ambi ious clima e change ac ion plan which is no add essed in his
s udy.
iod o mode a e infl a ion o e shoo in i s e o s o push
infl a ion upwa ds a e a long pe iod o unde shoo ing i s
infl a ion a ge . This willingness was la e ei e a ed in a
p ess con e ence by ECB P esiden Ch is ine Laga de
(ECB, 2021b). The ECB also announced ha i will include
he cos s o owne -occupied housing in i s infl a ion meas-
u e in o de o be e ep esen he infl a ion a e ha is
ele an o households (ECB, 2021a).
In o de o measu e he ex en o which he ECB missed
i s a ge in he a e ma h o he fi nancial c isis, one can
compa e he de elopmen o he ac ual HICP le el since
2009 wi h a coun e ac ual in which he ECB had exac ly
hi i s o me a ge , which is se a 1.9% annual infl a-
ion a e (Figu e 1). This compa ison shows ha he ECB
s ayed close o an ideal pa h un il 2013 bu signifi can ly
de ia ed om i since hen. In pa icula in 2014, 2015,
2016 and 2020 he ac ual infl a ion a e in he eu o a ea
ba ely a oided en e ing defl a iona y e i o y. In 2020, he
ac ual HICP le el was 8.4 pe cen age poin s below he
ideal HICP le el. Conside ing ha he ECB deployed un-
p eceden ed measu es o push infl a ion back on ack,
e.g. ze o o nega i e policy a es, quan i a i e easing and
o wa d guidance, his esul is sobe ing bu may well
ha e a oided an e en g ea e de ia ion om i s infl a ion
a ge .
Ta ge de ia ion and capaci y u ilisa ion
E en hough he ECB s essed he symme y o i s infl a-
ion a ge , i.e. ackling o e - and unde shoo s equally,
he willingness o accep a empo a y o e shoo , e en
o a ansi o y pe iod, can be c i icised as asymme ic
(Reu e s, 2021). Gi en ha he HICP le el conside ably
de ia ed om an ideal ajec o y, one can a gue ha a
In e economics 2021 | 5
296
In la ion
Figu e 1
HICP le el o he eu o a ea, 2009-2020
No e: Annual da a o he eu o a ea wi h changing composi ion: EMU16-
2009, EMU17-2011, EMU18-2014, EMU19-2015.
Sou ce: Eu os a , own calcula ions.
empo a y o e shoo me ely b ings he p ice le el back
on ack. Howe e , ha igno es he main unde lying mac-
oeconomic sou ce o low infl a ion, he unde -u ilisa ion
o p oduc ion capaci ies. Acco ding o he es ima es o
he Eu opean Commission, he a e age ou pu gap o he
eu o a ea be ween 2014 and 2020 was -1.2%, beginning
wi h -2.5% in 2014, peaking a +1.3% in 2019 and ending
wi h a s agge ing -5.9% in 2020, due o he pandemic-
induced ecession.
(1)  πi = c + βy
i + εi
Building on Hennecke (2018), he ela ionship be ween
infl a ion and he capaci y u ilisa ion can be modelled
and es ima ed using he signifi can he e ogenei y o in-
fl a ion a es and capaci y u ilisa ion o he 19 Economic
and Mone a y Union (EMU) membe s a es be ween 2014
and 2020. Equa ion (1) o mally s a es his simple Phillips
cu e in a linea ashion, whe e  π deno es he de ia ion
o he ac ual infl a ion a e in pe cen o coun y i in yea
om he infl a ion a ge , c he cons an e m, β he slope
pa ame e , y
 he ou pu gap in pe cen o he p oduc ion
po en ial and as an al e na i e measu e o he unemploy-
men gap in pe cen age poin s and ε he e o e m. The
unemploymen gap is calcula ed as he di e ence be-
ween he non-accele a ing wage a e o unemploymen
(NAWRU) and he ac ual unemploymen a e. Fo infl a-
ion, he yea -o e -yea change in he headline HICP in
pe cen is used, ob ained om Eu os a ; o he ou pu
gap and he NAWRU es ima es, da a om he Eu opean
Commission a e used, collec ed om hei AMECO on-
line da abase om which he da a o ac ual unemploy-
men a es was ga he ed as well.2
This model has he ad an age ha he cons an e m
yields he a e age de ia ion o he infl a ion o e he busi-
ness cycle, since he ou pu gap as well as he unemploy-
men gap should a e age ou o ze o. Hence, he es i-
ma ed cons an e m should no signifi can ly de ia e om
ze o i he ECB mee s i s a ge .
The eg ession esul s wi h he ou pu gap as a measu e o
capaci y u ilisa ion a e shown in Figu e 2 and Table 1. The
B eusch-Pagan es o he e ogenei y ejec s he null hy-
po hesis o homogenei y and he e o e ejec s he pooled
OLS model. Hence, unobse ed he e ogenei y needs
o be aken in o accoun which is done in model 2 by in-
cluding coun y-specifi c andom e ec s. Modelling ime-
specifi c andom e ec s (model 3) o bo h coun y- and
ime-specifi c andom e ec s (model 4) does no inc ease
he quali y o he model as he adjus ed R² dec eases con-
side ably. Hence, model 2 p o ides he bes fi o he da a.
2 The da a we e ob ained in July and Augus 2021.
Figu e 2
The EMU Phillips cu e wi h ou pu gap
No e: Annual da a o he EMU19 coun ies.
Sou ces: Eu os a , Eu opean Commission AMECO da abase, own cal-
cula ions.
Table 1
Es ima ion esul s: EMU Phillips cu e wi h ou pu gap
No es: *** 99% signifi cance le el; ** 95% signifi cance le el; * 90% signifi -
cance le el; - alues in pa en heses.
Sou ce: Own calcula ions.
Model 1 Model 2 Model 3 Model 4
Pooled Coun y-
specifi c
e ec s
Time-spe-
cifi c e ec s
Coun y- and
ime-specifi c
e ec s
Cons an -0.94***
(-12.09)
-0.93***
(-8.81)
-0.99***
(-4.90)
-1.01***
(-4.50)
Ou pu gap 0.16***
(7.71)
0.17***
(7.81)
0.10***
(4.92)
0.08***
(3.07)
Obse a ions 133 133 133 133
Adjus ed R² 0.31 0.31 0.15 0.06
B eusch-Pa-
gan (p- alue) 0.00*** - - -
95
100
105
110
115
120
125
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Eu o a ea ( eal)
Eu o a ea (on a ge )
index, 2009 = 100
-4
-3
-2
-1
0
1
2
3
4
-15 -10 -5 0 5 10 15
Ta ge de ia ion (%)
Ou pu gap (%)
ZBW – Leibniz In o ma ion Cen e o Economics 297
In la ion
When he unemploymen gap as a measu e o capac-
i y u ilisa ion is used ins ead (Figu e 3 and Table 2), he
B eusch-Pagan es o he e ogenei y does no ejec he
null hypo hesis o homogenei y. Hence, unobse ed he -
e ogenei y does no need o be aken in o accoun . Fo
obus ness checks, andom e ec s models we e es i-
ma ed none heless (models 3, 4 and 5). Compa ing he
models’ adjus ed coe fi cien o de e mina ion also shows
ha he pooled model is p e e able.
Rega dless o he measu e o capaci y u ilisa ion, he e-
g ession esul s indica e ha he e is a s a is ically signifi -
can ela ionship be ween he HICP infl a ion a e and he
capaci y u ilisa ion o he eal economy. Wi h a one pe -
cen age poin inc ease in he ou pu gap, infl a ion picks
up by 0.17 pe cen age poin s o by 0.2 pe cen age poin s
o he unemploymen gap. Mo e in e es ing o he pu -
pose o his s udy is ha he cons an e m is signifi can ly
below ze o in all models. Thus, o e he cou se o a ull
business cycle, he ECB unde shoo s i s infl a ion a ge
by abou one pe cen age poin .3 O pu di e en ly, in o -
de o mee i s new a ge o exac ly 2% annual infl a ion
a e, he ou pu gap would ha e o be a +5.5% and he
unemploymen gap a +4.7 pe cen age poin s. Gi en ha
he models a e linea and he ela ionship is expec ed o
u n non-linea , he mo e he ou pu gap exceeds ze o and
3 Ca ea : The ECB’s infl a ion a ge is defi ned o he EMU as a whole.
The eg ession yields he a e age infl a ion o an a e age EMU coun-
y. Hence, he coun ies a e no weigh ed acco ding o hei sha e in
he EMU agg ega e.
posi i e eedbacks a ise, he g ea e he chance ha he
2% a ge a e would in eali y p obably be me a a much
lowe posi i e gap, as demons a ed by model 2 wi h he
unemploymen gap as a measu e o capaci y u ilisa ion.
None heless, all models indica e a sys emic unde shoo
o infl a ion as he linea model is p obably a good app oxi-
ma ion a ound an ou pu o unemploymen gap o ze o.
Infl a ion ou look and policy implica ions
In ligh o hese esul s, he ECB’s announcemen o a
empo a y accep ance o an infl a ion o e shoo seems
jus ifi ed and can be seen as an a emp o a oid a u he
loss o c edibili y and a s abilisa ion o infl a ion and infl a-
ion expec a ions below he ECB’s a ge . The la es ECB
Su ey o P o essional Fo ecas e s conduc ed in he hi d
qua e o 2021, which can be seen as a p oxy o wide
infl a ion expec a ions, al eady yielded highe infl a ion
o ecas s o all ho izons. In pa icula , he infl a ion a e o
2021 is expec ed o be almos on a ge wi h 1.9%, up by
0.4 pe cen age poin s compa ed o he p e ious su ey
one qua e ea lie and be o e he ECB’s announcemen .
Howe e , he main easons a e inc eased ene gy p ices, a
be e g ow h ou look and he cu en supply sho ages in
some ma ke s (ECB, 2021c). The e ised mone a y s a -
egy mos likely did no play a subs an ial ole ye .
Figu e 3
The EMU Phillips cu e wi h unemploymen gap
No e: Annual da a o he EMU19 coun ies.
Sou ces: Eu os a , Eu opean Commission AMECO da abase, own calcu-
la ions.
-4
-3
-2
-1
0
1
2
3
4
-15 -10 -5 0 5 10 15
Ta ge de ia ion (%)
Unemploymen gap (pp)
Table 2
Es ima ion esul s: EMU Phillips cu e wi h
unemploymen gap
No es: *** 99% signifi cance le el; ** 95% signifi cance le el; * 90% signifi -
cance le el; - alues in pa en heses.
Sou ce: Own calcula ions.
Model 1 Model 2 Model 3 Model 4 Model 5
Pooled
linea
Pooled
non-linea
Coun y-
specifi c
e ec s
Time-
specifi c
e ec s
Coun-
y- and
ime-
specifi c
e ec s
Cons an -0.94***
(-11.4)
-1.02***
(-11.2)
-0.93***
(-9.5)
-0.98***
(-4.14)
-1.00***
(-3.95)
Unemploy-
men gap
0.20***
(6.40)
0.35***
(5.5)
0.21***
(6.09)
0.15***
(5.60)
0.11***
(3.43)
(Unemploy-
men gap)²
0.04*
(1.90)
(Unemploy-
men gap)³
0.00
(1.26)
Obse a ions 133 133 133 133 133
Adjus ed R² 0.23 0.26 0.21 0.19 0.08
B eusch-Pa-
gan (p- alue) 0.13 - - - -
In e economics 2021 | 5
298
In la ion
Whe he he ECB’s upda ed s a egy is success ul in el-
e a ing infl a ion back o a ge – and ealigns expec a-
ions wi h i – emains o be seen. Fo he nex wo yea s,
he o ecas e s expec infl a ion a es o me ely 1.5%. Fo
he longe e m, i.e. 2026, he su eyed o ecas e s ex-
pec infl a ion o be a 1.8%, and he e o e seem ancho ed
nea he a ge a e (ECB, 2021c). In any case, he ECB is
likely o back up i s announcemen wi h ac ion, as long
as he infl a ion emains below i s a ge and a pe iod o
inac ion, as soon as infl a ion exceeds i s a ge . Hence,
low o nega i e policy a es and conside able asse pu -
chases, wi h all hei po en ial side e ec s, a e p obably
he e o s ay o he o eseeable u u e. Wha migh help
he ECB o b idge some o he infl a ion gap a e i s plans o
g adually inco po a e he cos s o owne -occupied hous-
ing in i s infl a ion measu e. G os (2018) es ima ed ha he
inclusion o he cos s o owne -occupied housing could
inc ease measu ed infl a ion by 0.5 pe cen age poin s, i.e.
abou hal o he sho all iden ifi ed in his s udy. Howe e ,
he ECB (2016) i sel calcula ed he impac wi h a ma k-up
o me ely 0.2 pe cen age poin s.
Re e ences
ECB (2021a), The ECB’s mone a y policy s a egy s a emen .
ECB (2021b, 22 July), Ch is ine Laga de, P esiden o he ECB, Luis de
Guindos, Vice-P esiden o he ECB, Mone a y Policy S a emen
P ess Con e ence.
ECB (2021c, 23 July), Resul s o he ECB Su ey o P o essional Fo e-
cas e s in he hi d qua e o 2021, P ess elease.
ECB (2016), Assessing he impac o housing cos s on HICP infl a ion,
Economic Bulle in, 8/2016.
G os, D. (2018), Pe sis en low infl a ion in he eu o a ea: Mismeasu emen
a he han a cause o conce n?, Mone a y Dialogue, Feb ua y 2018.
Ha ik, K., K. Mc Mo ow, F. O landi, C. Planas, F. Racibo ski, W. Röge , A.
Rossi, A. Thum-Thysen and V. Vande meulen (2014), The P oduc ion
Func ion Me hodology o Calcula ing Po en ial G ow h Ra es & Ou -
pu Gaps, Eu opean Economy, Economic Pape s, 535.
Hennecke, P. (2018), A Simple Pos -C isis EMU Phillips Cu e – Impli-
ca ions o Mone a y Policy, In e economics, 53(6), 333-336, h ps://
www.in e economics.eu/con en s/yea /2018/numbe /6/a icle/a-sim-
ple-pos -c isis-emu-phillips-cu e-implica ions- o -mone a y-policy.
h ml (23 Sep embe 2021).
Reu e s (2021, 8 July), Reac ions o ECB’s s a egy e iew.