ECB’s de Cos: Model-Based Probability of Deflation Clearly Increased

12 June, 2020

By David Barwick – FRANKFURT (EconoStream) – The likelihood of deflation occurring in the euro area has risen, seen from a model-based perspective, European Central Bank Governing Council member Pablo Hernandez de Cos said on Friday.

Speaking at the 24th Annual European Financials Conference organised by Goldman Sachs, de Cos, who heads the Bank of Spain, said that monetary policy would react to whatever scenario occurred and that the ECB would do anything required to fulfill its mandate.

Noting the ‘discussion to what extent this crisis is an inflationary or deflationary one’, de Cos said that ‘[w]hat is obvious is that in the short run, there are quite a few disinflationary forces.’

The damping effect of weak energy prices on inflation has not been offset by higher food prices in recent months, he said, so that ‘the overall effect was clearly negative’.

‘With a more medium-term perspective, which of course … is the relevant one from the monetary policy perspective, I think it’s also important to emphasise that, for example, that market-based indicators of long-term inflation expectations remain stable, but at very low levels’, he said.

Indicators based on surveys are positive but near their historical lows, he said. ‘And perhaps even more important … model-based measures of the probability of deflation have clearly increased … in the last few months.’

Overall, he said, downward inflationary pressures are higher, as reflected in the ECB’s updated staff macroeconomic forecasts, and this was ‘one of the main justifications’ for the ECB’s latest policy measures.

On the subject of the steps taken by monetary authorities recently, de Cos said there were ‘at least three’ motivations for the expansion of the ECB’s pandemic emergency purchase programme (PEPP), first among them ‘relaxing the financial conditions in the euro area’, since ‘even after all the decisions that we’ve taken since the beginning of the crisis, financial conditions are still tighter now than they were at the beginning of the crisis.’

Secondly, he said, was the goal to ‘safeguard the transmission of our monetary policy to all asset classes and to all jurisdictions’ in the context of a heterogeneous currency area and the possibility of fragmentation.

‘And third, the measures should also contribute to … get us back to the pre-Covid inflation path‘, he said. ‘The risks of low inflation are there, even of deflation, they have clearly increased as a consequence of the crisis.’

In response to the pandemic’s economic fallout, the ECB reacted ‘in a commensurate way to the risk posed by the crisis to the outlook of the euro area economy, and of course to our … price stability mandate’, de Cos affirmed.

‘[W]e are continuously monitoring the situation and … stand ready to adjust all our instruments as necessary, because … the economic outlook is very uncertain and of course monetary policy will have to react to different scenarios … in a different manner’, he said.

‘What is clear is that the Governing Council remains absolutely fully committed to doing everything necessary to fulfill our … mandate’, he added.

How evenly distributed an economic recovery in Europe would be ‘is the big question that we all have’, he said. ‘It’s obvious that there’s still a lot of uncertainty.’

A potential second outbreak cannot be excluded, and ‘we are not completely certain that we are going to avoid’ some aspects of the economic crisis becoming permanent, he said.