Shadow ECB Council sceptical on fighting bubbles with rates

At the regular meeting of the ECB Shadow Council on 1 October 2009 there was unanimity that the ECB should not change its key interest rate at the next meeting. Moreover, none of the members would think that a rate change will be appropriate within the next three months either, barring unforeseen developments.

Growth forecasts made by Shadow Council members improved further. The average GDP forecast for 2009 improved to minus 3.9 percent. For 2010 members now expect growth of 1.0 percent on average. Hence the 2009 forecast is slightly higher than the ECB?s September projection (- 4.1) and the 2010 forecast significantly higher (ECB 0.2 percent) The Shadow Council?s inflation forecasts were largely unchanged at low levels and remain in line with the ECB?s projections.

20090.4 (0.3)-3.9 (-4.1)
20101.1 (1.1)1.0 (0.7)

Contributors:. M. Annunziata; E. Bartsch; J. Cailloux; J. Callow; M. Diron, G. Horn, S. King; .J. Krämer; T. Mayer; E. Nielsen; J.-M. Six
Assumptions: All forecasters assumed that the ECB would leave its key rate at 1% for the next six months.

On account of the improving economic outlook, all members considered the ECB?s key rate of 1.0 percent as appropriate. Anticipating little inflation pressure in the medium term future members considered that no rate hike will likely be needed within the next three months.

The discussion centred on the issue of how to deal with inflating asset prices. There was a general sense that the recent run-up in the prices of risky assets should still be considered healthy after the preceding sharp falls. However, members considered it necessary for the authorities to develop a strategy and assign responsibility in case asset prices should continue to go up strongly, to the point where a potentially dangerous new bubble might be blowing up.

Members agreed that, in order to define potentially unhealthy asset price developments, a broad range of indicators would have to be analyzed, including stock price valuations, credit spreads and other indicators of risk appetite, as well as lending and money growth. With regard to lending and money growth, some members cautioned that these can be rather lagging indicators.

The main disagreement was on whether the ECB and other central banks should take it upon themselves to use interest rate policy to lean against the emergence of a bubble, once the risk was identified. A majority cautioned against such a policy on the grounds that this might interfere with the main mandate of preserving price stability, a mandate for which the interest rate is the main tool. It was also argued that raising interest rates to rein in speculation and leverage might be misunderstood as a sign of confidence in the health of the economy. If so, the move might be counterproductive and spur on speculation instead of dampening it. For these reasons, the majority regarded it as a task of prudential supervision to make sure that no dangerous asset price bubbles are forming. While noting that the necessary international institutions and the rules to fulfil this task are currently not in place, these members argued that developing these institutions and rules was the right place to start.

Some members, however, argued that prudential supervision was covering mainly banks, but not other important parts of the financial architecture, like hedge funds and other unregulated entities. In contrast, it was argued, the key interest rate is a very important variable to guide the investment decisions of all financial market participants, banks and others. The minority admitted that the potential for misinterpretation of rate moves was there, but held that misunderstandings could be avoided by good communication of motives. Members of the majority countered that it was more promising to plug regulatory holes by extending prudential regulation to previously unregulated entities.

Several members warned that the ECB would not be able to achieve anything productive if they tried to counter asset price rises, since these tend to be a global phenomenon. It was argued that such an attempt - in the absence of international cooperation, in particular with the Fed - could drive up the already overvalued euro even more and force up unemployment even further.

One member mentioned that the ECB would automatically lean against the emergence of house price bubbles, if it used a definition of inflation which included the real price of owner occupied housing. In this case, a run up in house prices would show up in higher inflation, triggering rat4e rises.

Individual Votes

Members' individual votes for 3 September:
Jose AlzolaThe Observatory Groupno change
Marco Annunziata


no change
Elga Bartsch

Morgan Stanley

no change
Agnes Benassy-QuereCEPIIno change
Jacques Cailloux


no change
Julian CallowBarclays Capitalno change
Marie DironOxford Economicsno change
Gustav HornIMK Macroeconomic Policy Instituteno change
Stephen King


no change
Jörg Krämer


no change
Thomas Mayer

Deutsche Bank

no change
Erik NielsenGoldman Sachsno change
Jean-Michel SixStandard & Poor'sno change
Angel UbideTudorno change
Charles WyploszGrad. Institute. Genevano change

Frankfurt, 2. October 2009

Frankfurt, 2 October 2009
Norbert Häring
Non-voting Chair of the ECB Shadow Council


Quotes from individual members of the Shadow Council

(in no particular order)

During the inflation of the credit bubble the ECB has warned against excessive risk taking. Neither market participants nor regulators nor politicians have heeded this warning. The lesson from this is that the central bank needs use its policy rate to lean against excessive risk appetite, countering in a timely manner the downside risk to price stability emanating from the burst of an asset price bubble."
Thomas Mayer, Co-Head of Global Economics, Deutsche Bank

"The ECB should maintain its current bias towards maintaining the policy rate low for long by restating that the medium term inflation outlook remains very benign, a coded wording for saying that inflation remains too low relative to its comfort zone over the policy relevant time horizon."
Jacques Cailloux, Chief European Economist of Royal Bank of Scotland

"The ECB has to strike a delicate balance between growth risks and long-term inflation risks. It should make cristal-clear that it is willing to abandon unconventional monetary policy and to hike rates if there are clear signals that the economy is out of the woods."
Jörg Krämer, Chief Economist of Commerzbank

Background information

The ECB Shadow Council was founded in 2002 upon an initiative of Handelsblatt, the German business and financial daily. It is an unofficial panel, independent of the ECB/Eurosystem, and comprising fifteen prominent European economist?s drawn from academia, financial institutions, consultancies and research institutes. The Shadow Council usually convenes by telephone conference on a monthly basis (though in November it holds a physical meeting). Its discussions take place a week before the monthly official ECB Governing Council "policy" meetings, and are intended to formulate an opinion as to what monetary policy decision its members believe that the ECB's Governing Council ought to undertake, both at its forthcoming meeting and also on a three month horizon. Shadow Council members are encouraged to submit their own economic projections for euro area activity and inflation on a monthly basis, which constitutes the panel's forecast consensus as published each month. The Shadow Council's discussions and recommendations differ from surveys of economists concerning the outlook for ECB interest rates because the Shadow Council recommendation expresses the majority view of its' members opinion about what the ECB should do, rather than what they forecast it to do (and hence the "normative" views as expressed by Shadow Council members on what they consider the ECB ought to do can and often do differ from what they might say they expect the ECB to do). This "normative perspective can, however, give an early indication of shifts in the balance of opinion in the expert community, as can be seen by comparing the historic recommendations of the Shadow Council against subsequent decisions undertaken by the ECB Governing Council. Members of the Shadow Council base their recommendations on the ECB's objectives as defined under the EU Treaty, though Shadow Council members do not necessarily adopt exactly the ECB's specific interpretation of its mandate: most Shadow Council members consider that a medium term inflation objective of two percent with a symmetric tolerance band around it would be clearer, more realistic and more appropriate than the definition adopted by the Governing Council, which defines price stability as an inflation rate of "below, but close to, two percent", in the medium term.

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