ECB’s Stournaras: Ending Policy Support Early Could Cause Deflation

23 September 2020

By David Barwick – FRANKFURT (EconoStream) – The cliff effect that would result from removing economic policy support too soon in the current situation could lead to deflation, European Central Bank Governing Council member Yannis Stournaras said Wednesday.

In an op-ed piece for German business daily Handelsblatt, Stournaras, who heads the Bank of Greece, warned that rising Covid-19 case numbers could lead to further economic deterioration.

‘A premature withdrawal of the policy support could delay the recovery by generating a cliff effect, i.e., a sharp rise in insolvencies and bankruptcies, an increase in non-performing loans and in structural unemployment, and a decline in labor productivity as investment contracts on account of high uncertainty and weak economic prospects’, he wrote. ‘These factors, should they occur, could lead to a situation of secular stagnation along with sustained deflationary pressures.’

While policy support so far has cushioned the blow, the pandemic’s structural effects will pare down the size of those economic sectors most vulnerable to it, he said. ‘Moreover, a resurgence of the pandemic might lead to a deeper recession and a more delayed recovery than initially expected’, he added.

This situation requires the simultaneous support of fiscal, monetary and macroprudential policies and the withdrawal of this support to ‘be delayed until the recovery is well on track’, he wrote.

Stournaras urged that the establishment of the temporary recovery instrument Next Generation EU ‘not be seen as a one-off development but as the beginning of a more coordinated and systemic policy response to a serious external symmetric shock with asymmetric disinflationary consequences on member states.’

The allocation to Greece from the recovery fund as a percentage of GDP has been calculated to be significantly higher than that of any other euro area country.

The response to the crisis should also include the completion of banking union and in particular of a European Deposit Insurance Scheme for bank deposits in the euro area, Stournaras wrote. Such a scheme is the third pillar of the banking union, along with the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).

‘It is also imperative to be able to tackle the next generation of non-performing exposures and to facilitate the flow of credit to the real economy’, he continued. ‘This could involve the creation of Asset Management Companies, either at national or, preferably, at a pan-European level.’

On Tuesday, Stournaras was reported to have said that due to the pandemic, Greece’s stock of non-performing loans would expand by €8-10 billion from the €60 billion recorded end-June. The ratio of NPLs in the Greek banking system is significantly higher than that of any other euro area country.