Price stability offers security and confidence. This promotes sustainable economic growth.
What is price stability?
The ECB describes price stability as follows: annual inflation below but close to 2% over the medium term in the euro area as a whole. Inflation is measured using the Harmonised Index of Consumer Prices (HICP). It is about the average inflation of all euro area countries. In monitoring price stability the ECB looks at the medium term, because one-off peaks and troughs offset each other over time. Moreover, outliers cannot always be controlled by monetary policy. For example, if they are caused by wildly fluctuating oil prices.
Coronavirus crisis and ECB measures
The ECB is implementing a range of measures to mitigate the impact of the coronavirus pandemic on the euro area economy,including monetary policy measures and banking supervision measures. Christine Lagarde, President of the ECB: “ Extraordinary times require extraordinary action. There are no limits to our commitment to the euro. We are determined to use the full potential of our tools, within our mandate.” Read more about the measures taken by the ECB.
Coronavirus crisis and inflation
The impact of the coronavirus crisis on inflation is still unclear. The crisis causes a sharp decline in consumer demand, which has a downward effect on inflation. At the same time, it also causes a fall in the supply of goods and services, which has an upward effect on inflation. In addition, consumers’ spending patterns are changing as a result of the crisis. This leads to shifts in the composition of the consumption basket. This, in turn, has an impact on the measurement of inflation, because it is based on the prices of the products and services in the consumption basket.
Interest rates: gas and brake pedals
The ECB has no direct influence on rising and falling prices, but it does have instruments to influence inflation indirectly. One of them is interest rates. Under normal conditions, interest rates are the gas and brake pedals of the economy.
- Interest rate increase
Higher interest rates make it more expensive to borrow money. As a result, people and companies spend less money. And that puts a brake on the economy so that prices will rise less rapidly.
- Interest rate decrease
Lower interest rates make it cheaper to borrow money. This should encourage people and businesses to buy and invest more. In turn, that should raise prices and stimulate the economy.
Interest rate decisions
The ECB's Governing Council takes decisions on interest rates. DNB President Klaas Knot has a seat on the Council, as do the presidents of the other euro area central banks and the members of the ECB Executive Board. ECB President Christine Lagarde chairs the Governing Council.When setting the interest rates, the Council looks at economic developments and at growth and inflation prospects in the euro area. The main objective is to achieve price stability. To this end, the ECB sets policy rates, such as the deposit facility rate. This is the rate that banks have to pay for holding deposits with the central bank. Policy rates ultimatelty impact saving rates and mortgage interest rates.
Low interest rates, low inflation
Interest rates have been low for years now. They have been falling since the early 1980s. This is mainly due to structural causes beyond the ECB's sphere of influence, such as globalisation and population ageing. These factors cause prices to rise less rapidly. Read more about the economy, inflation and interest rate policy.
Risks of low interest rates
Long-Protracted low interest rates entail multiple risks:
- Investors are willing to take more and more risks in their search for yield.
- Low interest rates make mortgage loans cheaper and drive up house prices.
- Low interest rates put pressure on the financial position of banks, insurers and pension funds.
ECB policy review
The euro area has seen economic growth in recent years. However, the prices of products and services have increased less rapidly than expected. Businesses apparently set their prices in a different way than before. It is therefore important for central banks to carefully identify the factors that determine prices today. This is reflected in the ECB’s strategic review. ECB president Christine Lagarde has taken the initiative for this thorough policy reassessment. Read more about the ECB's policy review and its price stability and inflation objectives.