ECB should change inflation target, researchers to tell policymakers

FRANKFURT (Reuters) -The ECB should abandon targeting headline inflation and focus instead on price growth in discretionary spending to protect the bloc's poorest, a paper to be presented to policymakers at the bank's preeminent research conference argued on Friday.

The ECB targets inflation at 2% and a soon-to-be-concluded review will not even discuss the definition of the target as policymakers have long argued that using a different measures, like underlying inflation, or figures incorporating housings costs, could sow confusion.

But the paper written for the ECB Forum on Central Banking in Sintra, Portugal next week argues that the current framework disproportionately hurts low income workers and leads to an inferior outcome for society.

The logic is that after an interest rate hike, discretionary spending contracts significantly more than needed, triggering a fall in labour demand in sectors producing discretionary goods and services.

"These sectors employ a larger share of low-income, hand-to-mouth workers, whose consumption is highly sensitive to income fluctuations," the paper agued.

Thus, the initial drop in discretionary spending cascades into a broader decline of overall demand, amplified by this impact on lower-income households.

"By targeting discretionary inflation, the central bank provides households with an incentive to smooth their discretionary spending; in turn, this ameliorates the negative employment effects on hand-to-mouth workers in discretionary industries," the paper argued.

Although this would lead to a more accommodative policy stance, stabilising discretionary spending inflation allows the economy to more effectively close the so-called output gap, or the difference between potential and actual output, the paper argued.

(Reporting by Balazs Koranyi; Editing by Toby Chopra)

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