FRANKFURT (MNI) – Placing too strong a focus on core inflation
could lead monetary policymakers to underestimate overall price
pressures in the economy, European Central Bank Executive Board member
Lorenzo Bini Smaghi said on Wednesday.

In a speech given in Milan, Bini Smaghi also argued that it was a
mistake to assume that price stability was sufficient to guarantee
financial stability and to think it was less costly to “pick up the
pieces” after a financial bubble had burst rather than preventing one
from developing in the first place.

Citing an example where technological innovation or globalisation
could lead to depressed core CPI products, while demand out of emerging
economies boost food and energy prices, Bini Smaghi stressed that
focusing on core price trends “give misleading signals.”

“In these conditions, too much emphasis on core inflation can
distort policy inference,” Bini Smaghi warned. “Core inflation can
provide policymakers with a downwardly biased assessment of overall
price pressures and – mistakenly – suggest a pro-cyclical policy
course.”

At his press conference last week, ECB President Jean-Claude
Trichet warned that risks to medium-term price stability could move to
the upside due to short-term upward pressure stemming from global
commodity prices. But he said the ECB still assumed that the recent
spike in consumer prices would ease and that inflation would remain in
line with the bank’s medium-term price stability objective.

Governing Council member Anathasios Orphanides sought to downplay
Trichet’s inflation risk warning even further, noting that, “measures of
the underlying inflation rate remain rather low.” Among those measures,
he said, was core inflation.

But Bini Smaghi’s comment, though served up in a theoretical
speech, seems to cut the other way, providing a strong rationale for the
inflation warning.

An additional lesson that Bini Smaghi underlined was that the
policy process must include information on monetary and financial
imbalances, “whether in the form of a monetary pillar or in the form of
a leaning-against-the-wind attitude,” so that policymakers could
justifiably tighten rates, even in an environment of low inflation, in
the event of economic overheating or bullish financial markets.

“The reason is simple,” Bini explained. “Monetary and credit
imbalances which form alongside and – I would say – in symbiosis with an
asset price trend indicate that price stability might be endangered over
the medium term. Reacting to the monetary side of this symbiosis may
prevent larger problems from occurring subsequently.”

Although Bini Smaghi highlighted mistakes made during the crisis,
the central banker also complemented the ECB’s monitoring of monetary
and credit growth developments.

“There is indeed evidence for the euro area that without duly
taking the monetary analysis into account, inflation in the euro area
would have been distinctly higher at times of financial exuberance and
would have fallen deep into negative territory in the wake of the
financial market collapse, starting in the autumn of 2008. The economy
as a whole would have been more volatile.”

— Frankfurt Bureau: +49 69 720 142; email: frankfurt@marketnews.com —

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