Inflation in the euro area is too low, and the European Central Bank (ECB) is at risk of missing its price stability mandate. With the market forecasting average inflation in the euro area over the next five years in the 1.25 to 1.5 percent range, the ECB must prepare to act forcefully to push inflation higher. The ECB should (1) update the definition of price stability as inflation at 2 percent over 2 to 3 years to eliminate the ambiguity over the inflation objective; (2) reduce risk premia in the yield curve via a program of quantitative easing, making clear that this is a monetary policy operation—and thus legal under the Maastricht Treaty; and (3) ease the quantitative credit shortages to small and medium enterprises (SMEs) via a well-designed lending program, offering long-term funds at the policy rate to banks who lend to SMEs. These actions would restore price stability and encourage sustainable growth.
The data underlying this analysis are available here.