Inflation continues to be a major worry for central banks around the globe. As a consequence, the amount of discord over different monetary policy perspectives is becoming more pronounced. Notably, the European Central Bank (ECB) is guided by a clear mandate: to keep inflation below, but close to, 2%. This target reflects a broader consensus among economists and policymakers that stability in inflation rates is crucial for economic health.
Members of the ECB show sharply differing philosophies on how to achieve and keep this inflation target. “Inflation doves” vs “Hawks” Inflation hawks seek to raise interest rates, make savings more attractive and lower inflation. Put simply, “hawks” prefer a tight monetary policy, while “doves” are advocates of a looser one. First, doves like a little more inflation, on the theory that it helps juice the economy by keeping borrowing costs lower.
This enduring battle between these camps exemplifies the philosophical problem central banks will continue to meaningfully wrestle with as they guide economies through boom/bust cycles. The European Central Bank has shown its determination to keep inflation at, or very close to, 2%. This commitment drives every one of its policy choices.
The Hawkish Perspective
The hawks on the ECB’s council are equally unrepentant in their resolve to bring eurozone inflation back down to target. They assert that despite pain felt by many consumers, keeping inflation in check is necessary for preserving consumer purchasing power and economic stability overall.
Hawks claim that increasing interest rates is the only solution that can really cool down inflation. By increasing the benchmark policy rate, the central bank can discourage excessive borrowing and spending, which in turn helps to manage inflationary pressures. The logic here is predicated on the assumption that low inflation is a sign of an economically healthy economy. By contrast, unchecked high inflation tends to erode consumers’ buying power.
This singular focus on achieving an inflation rate of 2% or less is emblematic of a wider approach adopted by many central banks. Monetary hawks laud this strategy, ardently promising that they’ll stop at nothing until inflation returns to its pre-set target.
“If he wants access to the single market at zero tariffs, be reliable.” – Manfred Weber
This mood aligns perfectly with the hawkish school of thought, which holds that reliability and consistency in monetary policy is paramount to economic health in the long term.
The Dovish Approach
Dovish members of the ECB urge a looser monetary stance. They think that letting inflation run a little hotter than 2% will be enough to jump start the economy and lead to lower unemployment rates. For doves, the priority is creating more economic opportunity through lower interest rates and less stringent lending practices.
Doves argue that increased inflation is worth the trade-off of spurring more economic growth. They think a strong, loose monetary policy increases business investment. This, in turn, leads consumers to spend more, creating even more economic activity. This optimistic perspective reinforces an important misconception—that inflation is entirely good, if handled properly.
Additionally, the monetary policy doves underscore the importance of focusing on economic data, including employment and consumer confidence, when deciding on monetary policies. Further, they defend that these indicators convey important information about the current state of the economy and how it relates to inflation.
The Role of Economic Data
Additionally, central banks share a strong dependence on economic data in shaping their responses to inflation. Employment rates, consumer spending, and other indicators are key to determining the state of the economy.
Low inflation often signals a weak economy, prompting central banks to consider measures that can stimulate growth. Persistent high inflation can undermine consumer purchasing power, requiring a policy pivot to restore price stability.
Expectations of inflation are incredibly important in determining the decisions made by economic actors. When consumers and businesses expect prices to rise, their decisions can have self-reinforcing effects on aggregate demand and economic activity. Governments and central banks should be wary and not underestimate the implications of these expectations on their ability to fight inflation.
The ECB’s handling of inflation demonstrates their acute balancing act between hawkish and dovish philosophies. And yet the bank examines hundreds of sheets of economic data. This allows them to better focus their monetary policy to foster stability and grow the economy.