• Counterfactual scenario shows inflation expectations falling
  • ECB researchers say QE proves ECB’s commitment to mandate

Without the European Central Bank’s program of quantitative easing, inflation expectations in the euro area would have drifted away from the official target, giving rise to doubts about the institution’s credibility, a new study by ECB researchers says.

“The ECB’s expanded asset purchase program has been important in preventing a potential de-anchoring of inflation expectations,” according to the research article by economists Guenter Coenen and Sebastian Schmidt, published on the central bank’s website on Monday. “This, in turn, is vital in order to prevent a further prolongation of the period of low inflation outcomes through second-round effects.”

The study analyzes a scenario where the ECB didn’t implement purchases of government bonds from the beginning of 2015, concluding that the resulting spell of low inflation would have weakened the assumption by market participants and economists that inflation will ultimately stabilize at the goal of just under 2 percent. Instead, these expectations would have fallen to align with the actual level of price growth, signaling that consumers and companies had lost confidence in the ECB’s ability to keep inflation near its target.

“Longer-term inflation expectations are generally seen to be an indicator of the credibility of central banks in achieving their price stability objectives,” the study says. “The counter-factual simulation clearly illustrates the important role” of asset purchases “in forestalling a potential de-anchoring of inflation expectations by means of credibly signaling the ECB’s commitment to deliver on its price stability mandate.”

Source: ECB
Source: ECB

The de-anchoring would have resulted in a further slowing of prices and wage growth, which the central bank would have been unable to respond to because rates were already near zero. The compound effect would have been an appreciation of the euro and weaker economic growth. The annual inflation rate in the 19-nation euro area rose to 0.1 percent in June, after two months below zero.

“Over and above the direct effects resulting from expectations, the emerging slack lowers price pressures and further hampers the adjustment in inflation,” the study says.

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