ECB’s Lane: Measures to Add 1.3 Points to Output, 0.8 Point to HICP

24 June 2020

By David Barwick – FRANKFURT (EconoStream) – The European Central Bank’s decisions of the past several months would give substantial boosts over the medium term to growth and inflation, ECB Executive Board member Philip Lane said Tuesday.

In a speech for a webinar organised by Frankfurt Main Finance, Lane, who is also Chief Economist of the ECB, argued that the ECB’s dependence on asset purchases rather than additional rate cuts made for the more effective approach.

He cautioned that the next few months may bring little clarity with respect to medium-term growth and inflation developments.

The major policy decisions made by the ECB since March should add 1.3 points to output and 0.8 point to annual HICP over the forecast horizon, Lane said, citing ECB staff estimates. ‘These estimates of the macroeconomic impact of our measures are probably a conservative quantification of the effectiveness of our policy package’, he said, given that they ‘do not capture the benefit of preventing adverse non-linear dynamics.’

With respect to the counterfactual monetary policy response of a rate cut, Lane argued that this would have been inferior to the path chosen by the ECB focusing on asset purchases. Staff analysis suggests that ‘episodes of market stress are associated with a weaker pass-through of policy rate cuts to sovereign yields’, he said. ‘In fact, longer-term sovereign yields become virtually unresponsive to rate cuts in stressed conditions’.

The ECB would continue to monitor incoming information, though the data during the third quarter are unlikely to offer clear signals about medium-term economic and inflation developments, he said. This is because the nascent recovery of the current phase may not lend itself to extrapolation, but also because confidence may lag and fiscal stimulus programmes remain works in progress, he said.

In contrast, the case for the ECB to take further action at the Governing Council meeting earlier this month was ‘clear’, he said, given weak growth and inflation and the fact that ‘[t]he economic ramifications of the pandemic have been amplified by the tightening in financial conditions’.

Lane was hesitant in describing the post-lockdown economic improvement, allowing only that there were ‘some signs of an initial recovery’ and noting that the ‘process is expected to be quite gradual’. Output would regain its end-2019 level only at the end of 2022, he said.

The pandemic would have an overall impact on mid-term inflation that Lane called ‘disinflationary to a substantial degree’, with the downward pressure from the output gap probably greater than possible upward tendencies from supply constraints.

Monetary policy must provide sufficient accommodation, keep markets stable enough to ensure policy transmission, and supply liquidity, he said. Whereas ‘sizeable monetary accommodation’ and ample excess liquidity characterized the environment when the outbreak hit, he said, ‘since the start of the pandemic, we have no longer been able to count on a smooth transition of the changes in risk-free rates to other parts of the financial system and the real economy.’

The pandemic emergency purchase programme (PEPP) decided in March was ‘instrumental’ in addressing financial conditions, and the increase in its volume decided on June 4 helped further, he said. The two steps reduced the 10-year sovereign term premium by nearly 45 basis points, he said.

Another ‘significant contribution’ has been made by the adjustment to the third series of targeted longer-term refinancing operations [TLTROs], Lane said. The TLTROs are having a ‘net easing impact on the terms and conditions offered to borrowers and a positive net impact on their lending volumes’, he asserted.