Economists should start taking a long-term view of history by adapting to the fact that tomorrow's world will not necessarily be the same as today's, Isabel Schnabel, a member of the European Central Bank's executive board, said in an interview. With the Financial Times.
The central bank governor explained that warnings made in a book by economic historian Charles Goodhart about the risk of higher inflation were “ignored” and deemed irrelevant by ECB central bankers in 2020, who then believed that low inflation would remain the main concern. .
Goodhart's 2020 book – titled “The Great Demographic Reversal: Aging Societies, Declining Inequality, and Rebounding Inflation” – argues that population declines around the world will lead to higher inflation by causing labor costs to rise over the coming decades.
Schnabel said euro zone central bankers were too quick to ignore Goodhart's warnings, too caught up in their own thinking, as she blamed the European Central Bank's commitments to its own forward guidance for its late measures to raise interest rates as inflation rose after the pandemic. .
“The problem is that we were too caught up in our own thinking, and that also affected our policy reaction. We tied our hands too tightly with forward guidance,” Schnabel said. “That's the main reason why we were a little late in finalizing asset purchases and raising interest rates.”
“Inflation was falling and turning negative in the second half of 2020. We have seen very low inflation for many years. “Everyone was concerned that inflation would remain low or fall further,” Schnabel said.
The European Central Bank economist said that central bankers should have responded to Goodhart's warnings, as she said that economists must now start to become more flexible in their views, in realizing that economic conditions can change quickly.
“It would have been wise to listen to an economic historian like Charles Goodhart, who has seen the world change many times,” Schnabel said.
“What I learned is that we should not think that tomorrow’s world will necessarily be the same as today’s world. It can change very quickly,” Schnabel said. “Going forward, we must maintain more flexibility,” Schnabel said.
Schnabel said the ECB should also reconsider the way it issues future guidance, as she said all future guidance should be conditional on economic data, rather than absolute.
“If we go back to forward steering, it should be the Delphic type, which is forward steering conditional on economic data, but not the Odyssey type, where you figuratively tie yourself to the mast,” Schnabel said.
Schnabel also said that central bankers should be careful about basing their decisions on movement in financial markets, as she warned that doing so could end up creating feedback loops.
“We have to be careful about these market-based measures, because we might fall into Paul Samuelson's monkey trap in the mirror,” Schanbel said.
Neo-Keynesian economist Paul Samuelson's “monkey in the mirror” analogy seeks to compare central bankers who read too much into market movements to a monkey who sees themselves in the mirror and believes that by looking at their own images, they are receiving new information.
