Central bankers should avoid groupthink and start learning lessons from history, ECB’s Isabel Schnabel says

Economists should start taking a longer term view of history in coming to terms with the fact that the world of tomorrow will not necessarily be the same as the world of today, European Central Bank (ECB) executive board member Isabel Schnabel has said in an interview with the Financial Times.

The central banker explained that warnings put forward in a book by economic historian Charles Goodhart about the threat of high inflation were “disregarded” and deemed irrelevant by the ECB’s central bankers in 2020, who then believed low inflation would continue to be the main concern. 

Goodhart’s 2020 book – titled ‘The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival’ – argues that falling populations worldwide will drive up inflation by causing labor costs to rise over coming decades. 

Schnabel said the Eurozone’s central bankers were too quick to brush aside Goodhart’s warnings, due to being caught up in their own thinking, as she blamed the ECB’s commitments to its own forward guidance for its late action in hiking interest rates as inflation rose after the pandemic.

“The problem was that we were so caught up in our thinking and this also influenced our policy reaction. We tied our hands too strongly by forward guidance,” Schnabel said. “This is the main reason why we were a bit late on both ending asset purchases and hiking interest rates.”

“Inflation was falling and turned negative in the second half of 2020. We had experienced too low inflation over many years. Everybody was concerned that inflation would remain low or drop even further,” Schnabel said. 

The ECB economist instead said central bankers should have heeded Goodhart’s warnings, as she argued economists must now start to become more flexible in their perspectives, in realizing that economic conditions can rapidly change. 

“It would have been wise to listen to an economic historian like Charles Goodhart, who has seen the world changing many times,” Schnabel said. 

“What I’ve learned is that we shouldn’t believe that the world tomorrow will necessarily be similar to the world today. It can change very quickly,” Schnabel said. “Going forward, we should maintain more flexibility,” the ECB banker said. 

Schnabel said the ECB must also reconsider the way it issues forward guidance as she argued all future guidance should be conditional on economic data, rather than being absolute.

“If we ever went back to forward guidance, it should be of the Delphic type, which is a forward guidance conditional on economic data, but not the Odyssean type, where you tie yourself to the mast figuratively speaking,” Schnabel said.

Schnabel also said central bankers should be cautious 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 with these market-based measures, because we could be falling into the trap of Paul Samuelson’s monkey 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 with a monkey who sees themselves in the mirror and believes that by looking at their reflection, they are receiving new information. 

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