Like the Fed, the ECB has not been best served by changes to its monetary policy strategy last year that made it more dovish. Photo: ECB President Christine Lagarde

But yesterday’s account of the December ECB meeting still suggests that any such hawks are more than evenly matched by the doves. Former (German) ECB member Stark thinks that all this could lead to an existential crisis for the ECB. Could he be right?

Like the Fed, the ECB has not been best served by changes to its monetary policy strategy last year that made it more dovish. It now sees the 2% inflation target as symmetrical and not the "close to, but below" 2% that predated last July’s revisions. It also won’t consider ending policy accommodation until inflation is forecast by the ECB to be in line with the target from the middle of the forecast horizon and through the rest of the forecast period.

At the moment, the ECB is below this threshold at 1.8%. These revisions to its monetary strategy, allied to the fact that it sees inflation as still likely to be transitory, mean that the ECB is not talking about higher rates this year. The UK, which has a similar inflation rate, has already hiked, and the Fed, with 7% inflation, has started to taper and should hike from March 2022. So, the ECB seems to be going soft and, not for the first time, this seems to have forced the resignation of a German member of the ECB; this time, Weidmann, who quit late last year. An earlier quitter, Jurgen Stark, who resigned back in 2011, argued just recently that the ECB’s apparent refusal to countenance tighter policy now could lead to an existential crisis.

However, in the author’s view, it is not a predicament that can be solved by tightening policies, for that too could create its own existential threat. In short, Stark suggests that if the ECB does not adopt a tougher policy line, it will risk losing its credibility on inflation, and that could lead to significant damage through, for instance, a slump in the value of the euro. However, higher rates could lead to substantial debt problems in the region given that debt levels remain inflated and governments have come to rely on a "forever low" rate policy from the ECB.

In other words, the ECB is damned if it does not act quickly and aggressively to raise interest rates, and damned if it does.Stark, presumably, would prefer to see the ECB be damned via a faster and more aggressive move to tighten policy. But, as mentioned at the start, if the account of the December meeting is to be believed, there seems to be just as many, if not more, members concerned that there could be considerable damage to the euro zone economy if the bank is too hasty.

Some may recall the ECB raising rates in the aftermath of the global financial crisis in 2008, only to have to reverse the increase – and more – not long after.Policymakers don’t want to make that mistake again. But would they be? Inflation did reach a high of 3% a few years after the peak of the financial crisis, but this time it is much higher at 5%. The doves would argue that higher energy prices are behind much of the surge in inflation and should be discounted, and, to date, there have not been any significant second-round effects emanating from higher wages. These seem reasonable arguments and ones that seem to have held the ECB in good stead when it has taken a similar approach in response to previous oil price spikes.

However, there is a counterargument, coming from current German ECB member Schnabel, who says that higher fossil fuel prices might be a permanent cost of the green transition and so should not be discounted as we’ve seen in the past. This argument, too, seems to have some merit. In all, it seems to leave the ECB between a rock and a hard place. "Our sense is that the ECB will tighten up a bit, and that’s something that could give the euro a lift in the same way as we’ve seen for other currencies when policymakers seem to turn more hawkish," Mr. Steve Barrow, Head of Standard Bank G10 Strategy said.