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The ECB’s Deflation Obsession

It is hard to understand why the European Central Bank is currently so anxious to find new ways to make its policy stance even more expansionary. Its hyper-vigilance about falling prices is misplaced, and its ability to increase the rate of inflation is dubious.

BRUSSELS – Central banks aim for price stability, and today, prices are largely stable across much of the developed world. Yet central bankers declare themselves unsatisfied. Some policymakers, most notably at the European Central Bank, are even preparing further stimulus measures aimed at convincing financial markets of their resolve to fight deflation. But such policies overestimate the risk of falling prices.

For starters, prices are not falling now; they are just increasing more slowly than central bankers would like. In the eurozone, for example, core inflation (which excludes volatile energy and food prices) is running at about 1% per year, and markets expect it to remain at this level, on average, for the next decade.

The ECB regards such low inflation as totally unacceptable. It defines “price stability” not as stable – that is, unchanging – prices, but as year-on-year eurozone inflation of “below, but close to, 2% over the medium term.” Similarly, the United States Federal Reserve and the Bank of Japan have inflation targets of 2%.

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