Has the ECB Implicitly Combined an Average Inflation Targeting Regime with an Inflation Tolerance Band?

Abstract

In line with the consensus that price stability is the primary objective of monetary policy, central banks increasingly announce numerical inflation targets. However, recognising the inherent challenge of precisely meeting such targets, central banks often supplement these objectives with explicit or implicit tolerance bands. In the Eurozone, it remains unclear whether the ECB operates under a regime of point inflation targeting or employs an implicit point target with a tolerance band around the 2 per cent objective, potentially asymmetric prior to the July 2021 strategy review. This paper assesses whether, in practice, the ECB tolerated inflation deviations within a certain range, irrespective of the formal specification of its target. To identify the width of this range, we estimate a nonlinear monetary policy reaction function in which the response to inflation weakens within candidate intervals. The preferred specification is selected based on goodness of fit. We find that, until July 2021, the ECB’s behaviour was consistent with an inflation range between 1.0 per cent and 1.7 per cent. This result points to a lower tolerance for inflation close to 2 per cent, contrasting with the “below but close to 2 per cent” formulation and previous estimates in the literature, and indicating an asymmetric policy stance prior to 2021.