Is the ECB already following albeit implicitly an average inflation targeting strategy?

Abstract

A fundamental aspect of the ECB's monetary policy strategy is that it aims to pursue price stability over the medium term. However, the ECB has not defined the medium term with reference to a predetermined horizon. To shed some light on how the horizon of price stability is being achieved in practice, we have estimated a regression where the ECB policy interest rate is expressed as function of a j-period centered moving average of inflation forecasts, which may capture the length of the medium-term horizon orientation of monetary policy. We have tested for different combinations of policy horizons, and forecast horizons, to achieve the best fit. Allowing j to vary from 1 year (corresponding the standard inflation targeting regime) to a normal length of an economic cycle, we keep the model sufficiently general, and we let the data speak for itself. We have found that the ECB is targeting price stability over a period in between four years and a half and five years, implying that the ECB is area1dy following, albeit implicitly, a hybrid approach to price stability in line with average inflation target. This result is robust when we control for the Central Bank desire to avoid excessive policy interest rate variability due to the presence of policy interest rate adjustment costs.