ECB’s Visco: Overall Risk of Deflationary Spiral Can’t Be Excluded

10 June 2020

By David Barwick – FRANKFURT (EconoStream) – The risk of a downward price spiral can’t be ruled out, European Central Bank Governing Council member Ignazio Visco said on Wednesday.

In a virtual dialogue with Bloomberg, Visco, who heads the Banca d’Italia, said monetary policy could contemplate a gradual tightening only when inflation and demand clearly recover, circumstances not yet in sight.

A rising output gap and restrained wages in both advanced and emerging economies make for an environment that ‘implies that even raw material prices are going down dramatically’, he said, noting that a ‘clear’ impact on oil prices had already been observed at late February’s G20 meeting of finance ministers and central bank governors.

A constellation of inflation-damping factors ‘will probably stay with us for some time’, he said. ‘The risk is that disinflation is really not contained, and this is why we are so active on the monetary policy side. We have been observing tightening financial markets because inflation expectations are going down faster than the interest rates, and the overall risk of a spiral cannot be excluded.’

Extremely accommodative monetary policy globally has contained this risk ‘for the time being’, he said. Restoring price stability is ‘the basic issue’.

Turning to the ECB Governing Council’s decision at its regular policy meeting on June 4 to increase the size of the pandemic emergency purchase programme (PEPP) from the original €750 billion to €1.35 trillion, Visco identified two motivations.

‘The first is to enhance the easiness of the monetary stance, because this is the best response to a substantial fall in demand, and we don’t want the hysteresis being such that then demand remains low and very low for a long time’, he said. ‘The second is fragmentation’, he continued, given that the pandemic ‘has hit different countries in different ways, some earlier, some later, some more in depth, some less.’

Unwinding these purchases is a subject for well in the future, he made clear. As long as demand is subdued, inflation low and inflation expectations at danger of dis-anchoring, he said, ‘there is … nothing to say about this.’

He continued: ‘If there will be signs of increase in inflation, a clear increase in inflation, and there will be demand which recovers, then obviously the monetary policy has … all the reasons to become, if necessary, gradually, more restrictive. But for the time being this is not in the cards.’

Visco expressed satisfaction with the allocation of PEPP purchase amounts across jurisdictions, asserting that ‘[w]e should not exaggerate the issue’ of the capital key.

The PEPP allows flexibility in that the ECB tells the national central banks how much to purchase, guided by the key used to calculate national central banks’ respective share of the ECB’s capital, but with deviations as deemed necessary to ensure smooth policy transmission throughout the area.

‘If you look at the figures, we are still within reasonable ranges’, Visco said of divergences between asset purchase amounts and the capital key.

In other comments, Visco said that the reinvestment of maturing principal payments from securities purchased under the PEPP ‘has to go on for some time.’ The Governing Council on June 4 said that such reinvestment would continue until at least the end of 2022.

‘Certainly the monetary stance has to remain easy for a long time’, he added. ‘I mean, we still have projections that it will take years before we go to … what we define as price stability. We have to avoid mistakes.’