ROME (ITALPRESS) – “The ECB must remain pragmatic and rely on data.” Bank of Italy Governor Fabio Panetta writes this in an editorial in the Financial Times.
“The European Central Bank’s Governing Council noted that benchmark rates are becoming “significantly less restrictive.” This means that they are gradually approaching a neutral level, or R-star as it is known to economists. This level does not stimulate or constrain economic activity, but is the short-term interest rate that keeps inflation stable and full employment once temporary shocks have dissipated,” Panetta explained, noting that “R-star is a moving and invisible target” and “for the euro area, current estimates range between 1.5 and 2.5 percent in nominal terms.”
“This puts central bankers in a bind,” he continues. “On the one hand, R-star is essential: benchmark rates can only be considered ‘expansionary’ or ‘restrictive’ relative to it. On the other, it is elusive: an uncertain and changing benchmark is a shaky basis for policymaking.”
“To manage this uncertainty, central banks must use R-star pragmatically. When reference rates are to be anything but neutral, even rough estimates are useful. In 2022-23, the ECB knew that rates were well above neutral, deliberately, to fight inflation,” the BoI governor points out. “With them at 4 percent, even a 1 percentage point margin of error around R-star did not change its assessment: the stance was clearly ‘restrictive.’ But as inflation falls and rates approach neutrality, uncertainty becomes an issue. Policymakers enter a “gray area” where monetary policy may appear to be expansionary or contractionary depending on the R-star estimate used, rendering the estimates useless.”
Panetta then illustrates “a simple rule of thumb: when rates are to be anything but neutral, give weight to R-star estimates. They will not allow an accurate calibration of the position, but they help to assess whether monetary policy is expansionary or contractionary. When rates are close to neutral, focus on inflation projections and the broader macroeconomic outlook. If interest rates fall into the R-star gray area, inflation is falling toward target, and growth remains weak, policy is likely still restrictive. The ECB’s primary mandate is price stability. Neutral rate estimates provide a useful context, but should not dictate policy. At this stage, inflation projections provide better guidance.”
– IPA Agency Photos –
(ITALPRESS).
