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FRANKFURT – Christine Lagarde’s first major achievement as Chair of the European Central Bank has shown that she is good at papering the cracks.
Almost two years after her presidency, Lagarde undertook, in advance and with the full support of all Governing Council members, a profound overhaul of Europe’s most powerful financial institution – its first strategic review in almost two decades and the largest exercise since the common currency was introduced.
But her apparent victory in gaining unanimous support for the strategy review hides a chasm about what it actually means for monetary policy objectives.
In interviews with POLITICO following Thursday’s announcement, governors from Portugal and Ireland examined the diversity of opinion when translating the strategy into political decisions.
“We all have views and some of us have different views,” said Governing Councilor Gabriel Makhlouf.
As the eurozone struggles out of its deepest recession since World War II, Lagarde’s ability to persuade policymakers to adopt a common strategy has yet to be tested.
It is not long in coming: in a little over a week, those responsible at the bank will be debating an update of the ECB’s forward guidance, in which it sets out its expectations for the economy and the likely future course of monetary policy.
Lagarde is already preparing for turbulence.
“It will be tested every six weeks from now on,” she said in an interview published Tuesday with the Financial Times about the forward guidance. “But I’m under no illusion that we will have unanimous approval and general acceptance every six weeks because there will be some variations, some slightly different positions. And that’s okay. “
It had been widely expected that the review would not come until after the summer, especially after policymakers went public with conflicting views on the key issues of where the new strategy should pursue the central bank’s price stability objective.
One of the top ECB officials said it was a priority for the president to keep everyone on board throughout the process. Lagarde herself underlined at her press conference after the announcement how important full support is to her.
“This unanimity gives additional credibility to our commitment to meet our 2 percent inflation target,” she said on Thursday.
Since joining the ECB, the 65-year-old Frenchwoman has worked to overcome the divisive atmosphere in the Governing Council that her predecessor Mario Draghi left behind. Draghi had a habit, to the horror of many colleagues, particularly the fiscal hawks who advocated tighter monetary policy, of giving advance notice of decisions.
Governors approached for this article had nothing but praise for Lagarde’s leadership. “Your style is to reach consensus. And that’s important, ”said Makhlouf, Governor of the Central Bank of Ireland.
Makhlouf stressed that diversity of opinion is a positive element of discussions and praised Lagarde for her style in moderating agreements. She “invites us to speak, encourages us to move on if we talk too long,” he said. “Their style is certainly different from their predecessors.”
Mário Centeno, another member of the Governing Council, said Lagarde’s role in ensuring constructive debate and reaching an agreement was “crucial”.
“I was president of the Eurogroup for two and a half years,” said the Portuguese governor. “I know all about red lines, pink lines, green lines. I can tell you that the debate at this table was smooth and constructive. Differences were very easy to identify, but they have never affected this consensus-building mindset. “
But making unanimity a priority may have come at the expense of substance and clarity.
Policy makers agreed to change the inflation target from below but close to 2 percent to a target of 2 percent. The ECB also recognized that anchoring inflation expectations at 2 percent when interest rates hit rock bottom could mean “a transition period with inflation moderately above target”.
However, there is a wide range of interpretations as to how the indication that inflation has been exceeded may or may not alter the bank’s response function.
Lagarde herself, after repeatedly promising that the ECB would communicate more clearly when making political decisions, could not shed any light on the meaning of the vague reference. When asked about this at Thursday’s press conference, she simply repeated the agreed line with no information on how long or desirable a target overrun might be.
That left room for other policy makers to express their views.
Finnish Governor Olli Rehn, who had publicly advocated a move to a Fed-style average inflation target – where policymakers allow inflation to exceed the target to make up for earlier underruns – saw elements in the agreement of the ECB.
“I actually supported the decision with heart and soul,” he said of the change in the central bank and added: “Overall, the motivation for the strategy review and the analysis presented by the Fed and the ECB are not that far apart.”
“My interpretation of the strategy review is that the monetary policy response functions on either side of the Atlantic would not be that far apart if similar economic shocks hit both the United States and the euro area,” added Rehn.
But Makhlouf pointed out the differences. “We don’t do what the Fed does. We’re not doing an average inflation target. We don’t do makeup strategies, ”he said. “What we see is, especially when you are working on the lower limit [of inflation rates]that the actions you are taking may cause a temporary overshoot. We use the word transitory, which is even less than the word transitory. It’s almost by the way. “
It is not surprising that Bundesbank boss Jens Weidmann shared this more restrictive reading of the new strategy. “We do not make our monetary policy dependent on goals that have not been achieved in the past,” he said. “We are not aiming for lower or higher interest rates.”
In perhaps the most honest assessment, Bank of France Governor François Villeroy de Galhau conceded that policy makers did not have a firm definition of what a temporary overshoot might look like. “We didn’t discuss a duration; We haven’t talked about numbers. It’s all about the context, ”he said in an interview with Boursorama.
Or as Rehn put it: “There is still a lot of room for discretion, as it should be, because monetary policy is still as much an art as it is a science.”
The unanimous agreement on the examination language was sealed at the first personal meeting of the Governing Council since the beginning of the pandemic in the hills outside Frankfurt.
It remains to be seen whether the meeting will help set a constructive tone for the challenging discussions ahead, or whether disagreements will spill over into the discussions on forward guidance next Thursday.
One of the main points of contention is the Asset Purchase Program (APP), which some politicians want to extend until at least 2023. Some also advocate decoupling the APP from the bank’s promise to keep interest rates low.
“I think the forward guidance has to be adapted to the new strategy. I will contribute to a compromise, ”said Centeno. “I understand that we are benefiting from the unbundling of the APP and the interest rates in the forward guidance. In the current format, one of the decisions anticipates the other in a way that I don’t think is effective. “
Others disagree. “Personally, I would not be comfortable with what you just described on APP,” said Makhlouf when asked about the suggestion. “I’m not sure if it helps to limit ourselves to a specific timescale. I think we need flexibility. And in the world we live in, the more flexibility we have, the better. “
The future of the bank’s PEPP coronavirus emergency aid program is also heavily debated after the ECB promised to continue such purchases until at least March 2022.
At the June meeting, some political decision-makers saw scope to reduce the monthly purchase volume of bonds from the current EUR 80 billion, although most supported the proposal by Chief Economist Philip Lane to leave them at the current level.
ING economist Carsten Bzerski said that such an open challenge could only mean that resistance to the current course increases. “The rift between hawks and pigeons that was last seen in mid-2019 seems to be back,” he said in response to the minutes of the June meeting.
“With the strategy review presentation in mind, the July 22nd meeting will be extremely interesting,” Bzerski predicted.
If she is to continue her record of unanimous decisions, Lagarde may need to take her acclaimed negotiation skills to the next level.
This article is part of POLITICSPremium Policy Service: Pro Financial Services. From the Eurozone, the Banking Union, the Capital Markets Union and more, our specialist journalists will keep you up to date on the topics that determine the financial services policy agenda. E-mail [email protected] for a free trial.