By David Barwick – PARIS (EconoStream) – The economic fallout from the pandemic could warrant an extension of the European Central Bank’s asset purchases, ECB Governing Council member François Villeroy de Galhau said Tuesday.

In a speech for France’s Political Economy Society and an interview with Toulouse-based regional daily La Dépêche du Midi, Villeroy, who heads the Bank of France, suggested that increasing the volume of purchases would make more sense if the ECB simultaneously abandoned its (nominal) adherence to the capital key as a guide for allocating purchases across countries.

“The economic consequences of the crisis are likely to go beyond the end of 2020, and could justify a lengthening of the PEPP,” he said in reference to the ECB’s €750bn Pandemic Emergency Purchase Programme, adding that it would be useful to define with respect to the economic environment under what conditions the programme would be concluded.

Villeroy reminded that the ECB stood ready to increase the volume of the PEPP. “But that would only make sense in my view if in parallel we guarantee the maximum effectiveness of the PEPP, which leads me to … the allocation between countries,” he said.

The ECB would not allow “unjustified increases of interest rates in certain countries and a fragmentation that compromised the good transmission of our monetary policy,” he said. Villeroy cited ECB President Christine Lagarde’s comment a few days earlier that “the transmission of monetary policy is just as important as monetary policy itself”.

It would thus be an “unjustified constraint” for the ECB to stick to its capital keys in determining how to distribute its purchases across countries, he said.

“It’s not about targeting spreads or predetermined interest rates; ‘yield-curve control’ or a ‘spread control’ would be complex and even counterproductive in the Eurozone,” he said.

Nevertheless, he continued, under conditions of unwarranted spreads or the threat of excessive volatility, national central banks should have the latitude to adjust asset purchases accordingly.

With demand likely subject to a slower recovery than supply, inflation would probably stay low and interest rates with it, he said. Further ahead, medium term inflation developments are less certain, he said, so that “the differences between sectors could be significant and lead to relative price variations rather than a general upward movement.”

The ECB’s price-stability objective of annual HICP close to but less than 2% is “symmetrical, flexible and medium-term”, he said, meaning that “if our central target is seen as a ceiling, we are less likely to achieve it. And so, clearly, we will be prepared to move above 2% at times in the future.”

That the target is flexible means that “we can guarantee the 2.0% neither all the time nor immediately,” he said.

Villeroy said that the medium-term nature of the price-stability definition implies an orientation toward the future so as to guide expectations, without neglecting the past. Whether the ECB should “go so far as to target average inflation close to 2% and thus explicitly compensate for inflation shortfalls and excesses over time” is “an open question” that will be part of the ECB’s deferred strategic review, he said.

“A key question is then the period over which this average inflation would be assessed: it seems to me that the health crisis could justify, from its onset, at least temporarily, such ‘averaging’,” he said.