Why Lagarde shouldn’t touch monetary policy – for now

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One month into her mandate, new European Central Bank president Christine Lagarde has already said many times that she wants to “review” the monetary policy she inherited from predecessor Mario Draghi. What she means by that is unclear, and Lagarde has so far toed the line in her pronouncements about the policy itself. She seems eager to rebuild bridges with Germany, which had collapsed under Draghi. She is right: Her best contribution for now would be to stay the course and keep the policy unchanged.

It’s easy to see why she could be tempted down a different course. German public opinion has become estranged from the ECB, business confidence seems to have come back slowly after months of pessimism, and it would be natural for a new ECB president to be eager to put her mark on policy. None of these reasons, however, would justify a change of policy.

1- Germany: not as strident

German policy makers seem keen on giving Lagarde the benefit of the doubt, but German opinion, egged on by the screaming headlines of the country’s tabloid press, is still complaining about the low interest rates that hit a country of savers particularly hard. But the disconnect between the country and the ECB may not be as important as often described. A rising choir of German economists are defending the central bank. One of the country’s top economists, Marcel Fratzscher, the director of the Berlin-based German Institute for Economic Research, recently took to Twitter to denounce the “20 myths” most prevalent in Germany about the ECB. And another representative of this school of thought, Isabel Schnabel, has just been chosen as a member of the ECB’s six-strong executive committee.

Lagarde in other words, may benefit from some respite on the German side.

2 – The economy: still weak.

As Lagarde noted in her audition in front of the European Parliament on Monday, “euro area growth remains weak.” And the fact that the slump is due to causes that are beyond Europe’s reach – namely the trade disputes triggered by the US government – doesn’t mean that the ECB is powerless, she added: “Monetary policy can respond even when growth dampened by external factors.”

The first indications that confidence may be returning in the region still leaves the eurozone weak, and at the mercy of worsening relations between the US and China. That is not in itself a reason for the ECB to even hint it may phase out its “unconventional” policies. Inflation may have hedged up slightly in November (to an annual 1%) but expectations of what it may be in the future are still at “historical lows”, Lagarde reminded European MPs Monday.

3 – Lagarde: A learning curve.

The ECB president gave a few indications on what type of “review” the ECB’s top bodies will undertake “in the near future”. It will be a “strategy” review, she said, which will be based on “thorough analysis” and “an open mind”. But she also hinted that it would take many months, and run well into the end of 2020. Many things would deserve to come under review, and monetary policy has been the topic of enough intense debates in recent years to provide ample intellectual fodder for the impending review. Notably, isn’t it time to redefine inflation targets in an era where inflation itself seems to have declined to its lowest post-World War 2 levels?

Lagarde, reputed to be a hard worker and a fast learner, will use these months to make up her own mind on monetary policy. A lawyer by training, she is still for now, she told Parliament, “learning central banking”. That modesty alone also seems to insure that no major change of monetary policy should be expected in the months to come.