The decline in ECB credibility appears to be significantly correlated with the inflation performance in the euro area. But the loss of confidence in the ECB?s ability to deliver price stability in the medium term is not surprising considering the ECB?s befuddling communication practices.
First of all, its qualitative definition of price stability of ?below but close to? 2% is fuzzy. Furthermore, the explanations the ECB provides for its policy decisions are inadequate. For instance, the Eurosystem staff projections published in June showed a range of HICP inflation between 1.8% to 3.0% for 2009, assuming a three-month Euribor rate of 4.9% for 2008. Although the midpoint of this inflation projection range is uncomfortably above the 2% ceiling, the ECB left its main refinancing rate constant at 4% and merely expressed that the Governing Council is ?in a state of heightened alertness?.
The ECB?s inaction was surprising and its (lack of) explanation left journalists at its press conference puzzled over why rates had not been increased. Although the ECB raised the refinancing rate to 4.25% in July, this was insufficient to prevent a further drop in ECB credibility to well below 50% in the latest SPF.
The ECB faces a very challenging economic environment. But this means that now more than ever, the ECB would benefit from properly explaining its monetary policy actions. This would not only clarify the ECB?s thinking but also give it the opportunity to show that its monetary policy decisions are solely based on euro area considerations, in line with its mandate, and are not beholden to national interests.
Finally, the ECB should publish its policy rate projections and use scenarios to explain how it intends to act depending on economic developments.
?voxeu.org
