Fabio Panetta’s speech could well be the beginning of the ECB’s response to the Fed’s Average Inflation Targeting - assuming it is embraced by the rest of the Governing Council 1/9
The Fed’s move is based on the notion that it is easier to allow inflation to overshoot in the future amid decent cyclical conditions than to lift infla amid bad cyclical conditions. A pledge to overshoot tomorrow is thus credible and could lift inflation expectations today 2/9
A drawback of AIT is that it can send a signal of powerlessness today, or even justify a certain immobilism in the short run: “since I promised something for the future, don’t ask me to do more today” 3/9
Panetta’s focus on asymmetry focuses on the here and now. The theoretical premise is that it’s harder to lift an economy out of entrenched deflation than to curb inflation once it’s back (the Mishkin rule). So a CB must do all it can NOW to avoid a deflationary spiral 4/9
The ECB should therefore throw everything it has at the economy, even at the risk of doing “too much”. It will always to time to correct this in the future. 5/9
AIT could be part of the package, but our impression is that Panetta is more focused on more policy moves soon - probably another recalibration of QE. 6/9
The question of course then shifts to HOW the ECB could throw more at the economy. Panetta’s speech is consistent with moving the limits of QE further, either through a bigger/longer PEPP or extending to PSPP the limit relaxation already implemented on PEPP. 7/9
Panetta pre-empts objections on the “diminishing returns” on monetary policy by talking a lot about fiscal policy. He is right IMHO. At the moment, allowing fiscal policy to be bold by ensuring easy funding conditions may be the most efficient transmission channel for the ECB 8/9
Let’s see how Panetta’s speech is received by the rest of the Gov council, but there is a cogent dovish programme on the table. Key issue of course is how cooperation between fiscal and monetary won’t end up in permanent fiscal dominance, but that’s for another thread 9/9
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