ECB’s Holzmann: Should Discuss How and When to Unwind Policy Measures

11 September 2020

By David Barwick – FRANKFURT (EconoStream) – The European Central Bank should not defer deliberations about how and when to unwind the measures taken to mitigate the economic fallout from the pandemic, Governing Council member Robert Holzmann said on Friday.

In remarks at the Konrad-Adenauer-Haus in Berlin, Holzmann, who is Governor of the Austrian National Bank, implied the possible desirability of a more fundamental undoing of the ECB’s policy arsenal, and voiced concerns about the longer-term side effects of very low interest rates and asset purchases.

Holzmann urged not waiting to engage in discussion about ‘when and how a structured, situation-dependent decoupling of monetary policy from the current exceptional emergency measures is feasible.’

An unwinding of extraordinary policies, he observed, is tied to ‘the even more fundamental question of whether the expansion of the monetary policy arsenal of instruments that has taken place over the past decade can and should be dismantled’.

In view of structural developments that could hinder monetary policy from reaching its medium-term objective without relying on non-standard instruments, ‘a broad debate on future monetary policy strategy - i.e. the interaction between instruments and objective - is very welcome.’

The ECB’s strategy review represents the ideal opportunity for this, he said, suggesting that the U.S. Federal Reserve’s own such review offered many ideas of relevance.

Above and beyond the ECB’s review, he said - noting the plan to share its outcome around mid-2021 - ‘in view of the hopefully speedy resolution of the crisis, a discussion about the timing and form of monetary policy normalisation should be held.’

Holzmann affirmed the necessity of expansive fiscal policies as a complement to loose monetary policy, ‘especially in view of the expectation that it will take relatively long for a return to the old production and employment path.’

While welcoming in this context Europe’s establishment of a recovery fund, ‘the incentives created by the financing of the fund are not unproblematic’, he said. Monetary policy will have to guard against the encroachment of fiscal imperatives, he said.

‘Past crises show that the temptation to fiscal dominance can be considerable in recovery phases with high levels of public debt’, he said. ‘We should therefore start thinking now about how to prevent even the slightest risk of fiscal dominance and its negative consequences for the independence, reputation and credibility - and hence the effectiveness - of monetary policy.’

The May 5 decision by Germany’s Constitutional Court declaring partly unconstitutional ECB bond purchases made during the euro crisis under the public sector purchase programme (PSPP) ‘did not diminish the effectiveness of our monetary policy’, he said, but put a premium on the proportionality of ECB measures.

This in turn makes it yet more important to consider the potential for negative side effects of unconventional policies, he said. ‘Such side effects can take various forms: very low key interest rates and extensive bond purchase programmes imply a low discount factor’, he said. ‘Low risk-free interest rates trigger portfolio shifts towards riskier assets.’

Portfolio shifts can promote investment in the real economy, he said, but also lead to higher prices of assets like stocks and real estate, which can ultimately pose financial stability risks as well as influence the distribution of wealth.

Low financing costs can also eventually impede productivity growth by making attractive investments unlikely to be profitable in the long term, he said, or by reducing the pressure on companies to innovate and operate efficiently, enabling the survival of unprofitable firms.

‘If this were the case, an expansionary monetary policy could, despite its short-term growth-supporting effects on the demand side, weaken productivity and potential growth in the long run’, he said. ‘As a result, monetary policy itself could also be partly responsible for the fall in natural interest rates. In other words, monetary policy itself would then push down its "benchmark interest rate", thereby exacerbating the problem of the zero interest rate floor itself.’

Holzmann made clear that Europe is already in the ‘rebuilding phase after the crisis’.