ECB’s Knot: Need Ample Policy Support for Extended Period of Time

25 June 2020

By David Barwick – FRANKFURT (EconoStream) – The economy is going to require considerable policy support for quite a while, European Central Bank Governing Council member Klaas Knot said Thursday.

In remarks at the Reinventing Bretton Woods Committee Webinar Series, Knot, in contrast to his Council colleagues, suggested that whether the pandemic would have an overall disinflationary effect was an open question, according to a text provided by the Dutch National Bank, which he heads.

The policy response to the economic fallout from Covid-19 ‘has been crucial to avert even worse outcomes for now’, he said. Various indicators show the economy emerging from the initial shock, he said. ‘So I would say that recent data solidifies the confidence in our baseline scenario, and should allow us to gradually move away from more severe scenarios’, he said.

Even so, output will close in on the level from before the crisis only at the end of 2022, he said. ‘Looking ahead at the recovery, it is clear that ample policy support to the economy will remain important for an extended period of time’, he said.

The proper policy response further down the road will also depend on the net inflationary impact of the shock, he said. While the demand shock prevails for now, later on, ‘negative supply effects can very well gain in relevance as businesses adjust their production processes to the new environment.’

Such effects would imply upside pressure on prices and thus ‘impact on the intensity with which monetary policy can continue to support the economy’, he said.

Moreover, with time, increased clarity about the future should spur private demand and induce a drawdown of public sector spending, he said. A withdrawal of the fiscal stimulus seems appropriately accompanied by less monetary accommodation, he said.

An adjustable policy mix helps safeguard against excessive reliance on specific policy elements that could be associated with undesirable side effects over time, he said.

‘In the previous recovery from the euro area debt crisis, relying too heavily on monetary policy to get the job done has contributed to perceptions of a “central bank put”, which has fed into global concerns about ratcheting up of debt levels and excessive leverage’, he said. ‘Such concerns have recently become manifest for instance in the corporate sector.’

Knot welcomed proposals for a European Recovery Fund, which he said would meet investment needs and also ‘provide an important signal that we do not stop short at only stabilising our economies, but also take the opportunity to address common longer-term challenges, thereby solidifying the recovery to take root.’