ECB’s Villeroy: IMF’s European GDP Forecasts Too Pessimistic

29 June 2020

By David Barwick – PARIS (EconoStream) – The latest growth forecasts of the International Monetary Fund are unduly gloomy with respect to Europe, European Central Bank Governing Council member François Villeroy de Galhau said Monday.

In an interview with German business daily Handelsblatt, Villeroy, who heads the Bank of France, indicated that he was open to increasing banks’ exemption under the ECB’s tiering system.

The economic collapse in the wake of the pandemic was ‘absolutely brutal, but the worst is behind us’, he said. For France and for Europe, the recovery will take the form, graphically speaking, of a V with a flatter right side, akin to a bird’s wings, he said. ‘The most recent IMF projections for Europe are too pessimistic’, he added.

In its World Economic Outlook Update published last week, the IMF said growth in the euro area would contract by 10.2% this year and then rebound 6.0% next. The ECB issued updated staff macroeconomic projections on June 4 supporting a baseline scenario in which real GDP in the area declines by 8.7% in 2020 and expands 5.2% in 2021.

Asked if there should be an increase in the level of credit institutions’ excess liquidity holdings to which the ECB, under its two-tier system for reserve remuneration, does not apply negative remuneration at the rate applicable on the deposit facility, Villeroy responded that he had been ‘one of the biggest advocates of tiering, and it is a big success. … If we can optimize the exempt amount in the future, why not?’

Tiering under the ECB, in effect since the end of last October, allows credit institutions to avoid remunerating - at the currently negative deposit rate – a portion of their reserve holdings in excess of minimum reserve requirements. This is done via the application of two different interest rates that apply to different shares of the institutions’ excess reserve holdings. In this way, the ECB seeks to safeguard both the transmission via banks of its monetary policy and the benefit in terms of monetary accommodation of negative interest rates.

Villeroy insisted that the ECB would not assume sovereign debt and thus violate the prohibition on monetary financing. ‘There can be no question of the ECB giving a guarantee for government debt or guaranteeing a certain spread between euro countries’, he said. As well, the ECB cannot give in to fiscal dominance, he said.

The duration of extremely loose monetary policy depends on prospects for inflation, he said, describing himself in this regard as ‘very close to the traditional German position that we have a central mandate, price stability.’ Policy must remain very flexible until price stability is ‘clearly attainable’, he said.

The debate about adding junk bond purchases to the ECB’s pandemic emergency purchase programme (PEPP) is ‘probably not urgent’, he said. Although he excluded buying bonds that had already had such a status prior the crisis, he did not rule out purchasing bonds downgraded only during the crisis.

The strategy review, the conclusion of which the ECB in early April deferred from the end of 2020 to mid-2021, has to respect the fact that the pandemic has ‘intensified the deflationary tendencies that are weighing on our economies’, he said.

‘Maybe we will clarify the inflation objective and in any case confirm that it is symmetrical, that’s part of one’s credibility’, he said. ‘If below but close to 2% were an upper limit, the objective would never be reached.’

The launch of the strategy review had been announced on January 23, at which time the ECB indicated that the scope of the review would focus on “quantitative formulation of price stability, monetary policy toolkit, economic and monetary analyses and communication practices,” while financial stability, employment and environmental sustainability would also be part of it.

Villeroy denied being either in favor of or opposed to an objective of medium-term average inflation below but close to 2%. ‘The question is whether we could compensate for the failure to hit the inflation objective since the beginning of the crisis by striving for a somewhat higher inflation later’, he said. ‘That is an open question that can be dealt with in the strategic review.’