ECB chief Mario Draghi asks banks to be careful with new policy models

ECB's asset purchases, aimed at boosting inflation, is set to expire at the end of the year

Unconventional monetary policy is a success, but gaps in understanding the relatively new tools remain, European Central Bank President Mario Draghi said on Wednesday, cautioning against hasty policy responses to the new reality.

Emphasising the need for rigorous research, Draghi said central banks need to carefully weigh their policy steps, giving up their defence of obsolete approaches while acknowledging gaps in their knowledge of how new policies work.

Draghi's comments come as the ECB is confronted by an economy where robust growth is accompanied by anaemic inflation. It is a combination that has raised questions about the validity of older doctrines on inflation, its relationship to employment, and central banks' ability to affect price growth.

"(John Maynard) Keynes is often quoted as saying, 'When the facts change, I change my mind. What do you do, sir?'" Draghi said. "Well, for policymakers, it is not that simple, and research helps us to decide whether a change in the facts deserves a policy response or, as we say, we should look through it."

"We must be aware of the gaps that still remain in our knowledge," Draghi said in Lindau, Germany, in a speech that did not discuss current monetary policy.

The ECB is not alone. The minutes the US Federal Reserve's last meeting showed some policymakers were concerned about the validity of their models, since inflation was failing to accelerate despite near-full employment and growth above the economy's potential.

For Draghi, the dilemma will have to translate into concrete action this autumn. The ECB's asset purchases, aimed at boosting inflation, will expire at the end of the year, requiring policymakers either to extend purchases or start winding them down.

Economic growth is at its fastest since early 2011 and unemployment recently hit an eight-year low, but inflation looks set to undershoot the ECB's target- just under 2 per cent- at least through 2019.

Draghi defended the unconventional monetary policy, though, arguing that it has succeeded in the face of extreme shocks and proved that central banks remain potent even when interest rates bottom out.

"Policy actions undertaken in the last 10 years in monetary policy and in regulation and supervision have made the world more resilient. But we should continue preparing for new challenges," Draghi said.

"A large body of empirical research has substantiated the success of these policies in supporting the economy and inflation, both in the euro area and in the United States," Draghi said.