Sustainability is Price Stability — Covid-19 Crisis Pushes the ECB to Re-evaluate Inflation Policy

The European Central Bank in Frankfurt, Germany. Photo by Charlotte Venema on Unsplash.

The primary objective of the European Central Bank (ECB) is maintaining price stability. In practice, this has meant ensuring that inflation stays below, but close to 2 percent. Since the European sovereign debt crisis of 2012, the ECB has struggled to reach the target, and now the economic crisis kicked-off by Covid-19 has sounded the alarms of deflation. These developments have brought the secondary objectives of the ECB to the forefront; the objective of supporting the general economic policies of the European Union, including employment, sustainable growth, and environmental protection. How to do this, is a question a recent report co-authored by Professor Kern Alexander from the Center of Competence for Sustainable Finance seeks to answer.

“With or without Covid-19, we have the Sustainable Development Goals to reach by 2030. The United Nations estimates an approximate 2.5 trillion annual funding gap to reach these goals by the deadline. This is where the ECB should — and could — come in,” Professor Alexander begins.

“The ECB’s secondary mandate makes it clear that sustainability and solidarity are at the core of its mission. The ECB can utilized its monetary policy tools to combat the current economic crisis in a way that supports sustainable economic growth while also achieving its primary objective of price stability.” he elaborates.

The ECB Mandate: Perspectives on Sustainability and Solidarity report published in the first week of June is part of ECB president Christine Lagarde’s monetary policy review kicked off in January. The ECB review is the first monetary policy strategy review in 16 years and is expected to re-evaluate the bank’s strict approach to price stability — for example.

European Central Bank’s president Christine Lagarde. Photo by the ECB.

The review process began before the Covid-19 crisis, yet the unprecedented crisis is expected to alter the recommendations drawn from the review.

Professor Alexander dissects three key points from the report to elaborate on how the ECB can use the current financial crisis to stimulate sustainable economic growth.

Why should the ECB lift sustainability and solidarity up on its agenda? Will this not jeopardize price stability?

The typical way the ECB works is that it utilizes a number of monetary policy tools, which include setting interest rates on inter-bank loans and creating credit for the banking system by electronically printing money. This money can then be used to purchase the bonds of banks, corporates, and governments in order to stimulate the economy to achieve the primary target of 2% price inflation.

When it comes to the sustainability debate, our report makes the case for setting a more flexible primary target for inflation and steering investments toward sustainable economic growth. In other words, stimulating a stagnated economy by creating credit for sustainable sectors of the economy and buying the bonds of companies involved in sustainable economic activity. This way the economic growth enabled by the ECB will be in line with its secondary objectives, including sustainable growth and environmental protection.

When we place the sustainability approach in medium to long-term economic trajectories, enabling and prioritizing sustainable growth has a strong impact on the successful implementation of ECB’s primary objective of price stability. Pandemics, extreme weather events, and other crises caused by unsustainable growth are bound to become more prevalent and destructive unless climate change mitigation and adaptation succeeds. Steps taken to reach secondary targets are steps taken to prevent future crises while ensuring price stability.

Sounds clear and sensible. Why has this not been done before?

Until now and historically, the ECB has been focused on its primary objective of price stability that is defined as a 2% consumer price inflation target. During the early years of the euro, the ECB generally achieved its inflation target, but since the European sovereign debt crisis of 2012, inflation has been below target, and in some cases below 0%, which is deflation. Now with the Covid-19 crisis the risk of deflation is prominent and widespread. This risks further stagnating an already stagnant economy through the increase of the real value of debt. In a context where countries are taking on historic amounts of debt to get through the ongoing crisis, deflationary risks can have serious consequences.

If the ECB would adopt a more flexible approach to inflation, say an inflation rate that would range between 2–4%, the ECB could utilize its policy tools to push more actively for sustainable growth. Further, even now, the ECB can use its mandate to buy the bonds of Eurozone states, banks and companies in order to stimulate stagnant economies so that inflation can increase to the current target of about 2%.

Some say that this is not within the mandate of the ECB. Yet, in the Weiss case, the European Court of Justice ruled in 2018 that one of the ECB’s asset purchase programs, the Public Sector Purchase of Bonds program, was indeed lawful. The program met the proportionality requirement of EU law.

The ECB’s asset purchase approach to stimulating the economy can also be seen in the ongoing Pandemic Emergency Purchase Programme (PEPP) which the ECB adopted in March and increased to 1.3 trillion euros on June 4th. The PEPP is temporary in nature, but can pave the way for the adoption of future asset purchase programs that provide a more systematic way of supporting and mainstreaming sustainability into the ECB’s policies. The biggest hurdle in the way is political will.

According to Professor Kern Alexander, sustainability could and should be made an integral part of the ECB’s economic response to the Covid-19 Crisis.

What do you expect to come out of the review?

I do not expect the inflation target to see much adjustment as the political push to maintain the 2 percent benchmark is strong. However, the pressure to re-think inflation and the tools the ECB should and could use to stimulate the Eurozone economy will grow. I do expect sustainability and climate change to have a bigger role in ECB’s strategy going forward. The connection between the loss of biodiversity, climate change, and the Covid-19 pandemic is widely accepted. The price stability target will probably not be achieved in the future if monetary policy does not more actively support sustainable sectors of the economy.

Read the full The ECB Mandate: Perspectives on Sustainability and Solidarity report here.

For more information and interview requests, reach out to:

Anna Tervahartiala
+41 77 960 5518

Professor Kern Alexander



Center of Competence for Sustainable Finance @UZH

The Center of Competence for Sustainable Finance is interdisciplinary university center dedicated to research in substantial finance.