ECB’s Visco: Broad Consensus on Need For Long Period of Accommodation

11 October 2020

By David Barwick – FRANKFURT (EconoStream) – There is a ‘broad consensus’ on the need for monetary policy to remain accommodative for a long time to avoid the potentially dangerous consequences of persistently undershooting price stability, European Central Bank Governing Council member Ignazio Visco said on Sunday.

In an interview with Italian daily Corriere della Sera, Visco, who heads the Banca d’Italia, said that fiscal and monetary policy must prevent a negative spiral in which higher propensity to save leads to a prolonged period of lower aggregate consumption, reducing economic activity and ultimately resulting in lower employment, income and total savings, a vicious circle he called ‘the economic phenomenon that worries me the most’.

‘It is essential to continue to have accommodating policies until this component, even psychological, linked to uncertainty disappears’, he said.

Even without the decline of energy prices, behind currently negative European inflation rates, the distance between inflation and the ECB’s price stability objective has ‘effects that can be dangerous’, he said.

In particular, he elaborated, expectations can weaken, leading to lower wages and prices. Given that nominal interest rates are hard to lower further, real interest rates would rise, crimping demand and leading to higher real debt, he said.

"This is why monetary policy must be expansive and remain so for a long time,’ he said. ‘There is a broad consensus on this.’

Visco observed that at end-March, market-based measures of inflation expectations implied a 40% chance of deflation in the Eurozone over the next five years, which would be a ‘very serious’ situation. This probability declined to 20% as of September, he said.

‘But 20% is not an indifferent risk and is why monetary policy must remain accommodative for a long time’, he said. ‘We have shown that we can intervene with monetary policy.’

The lower probability attached now by markets to a deflationary scenario is due to the introduction of the pandemic emergency purchase programme (PEPP), he said. ‘We also said that we are completely open to continue using the tools we have, and this is one of them’, he added.

Asked explicitly if that meant going beyond previous decisions, Visco replied, ‘If it were necessary, of course. We have already said that. The point is what tools should be used. Even more negative interest rates? We know that there is a level below which there is more harm than good. So there must be a role for unconventional monetary policy and, as Keynes said, there must be a role for budgetary policy.’

If the monetary base rather than taxes or debt were used to finance government, this would be a ‘legitimate concern’ because ‘it would end up compromising the independence of central banks with very serious consequences in the long run’, monetary policy no longer being perceived as a credible bastion against high inflation, he said.

‘Having said that, I do not believe that we should take these risks too seriously today because, if we do not act in accordance with budgetary policy to support the economy and bring demand back to the right levels to regain price stability, we could end up losing independence for the opposite reason’, he said.

Turning to the ECB’s newly resumed monetary policy strategy review, Visco said surveys showed that the current price stability definition was ‘vague, difficult to understand’.

‘We say we would like an inflation rate below but close to 2% in the medium term’, he said. ‘I believe instead that the target should be symmetrical’.

The objective also ‘must be kept at a level quite far from zero’, he urged. Inflation of 1.5% is too low, he said, ‘because we need sufficient margins of flexibility to cope with crises and we must also take into account continuous, rapid and very strong technological innovation that tends to reduce prices and distort the statistical estimate of their growth.’

Visco also criticized communication practices. ‘But above all, we need clarity of purpose’, he said. ‘It is not a good thing that monetary policy decisions are followed by a series of press releases from some national central banks and more or less episodic statements from us members of the Governing Council’.

That does not mean, however, that only ECB President Christine Lagarde should speak, he said. Rather, the policy meetings should be more transparent. ‘There would be nothing wrong with all of us being explicitly attributed our own thoughts in the minutes of the meetings’, he said. ‘We would also make ourselves better understood by the public, and you would find that there are far fewer differences of opinion than you often think.’

In other comments, Visco said the economic recovery in Italy ‘is going more or less as expected’, he said, but it is important to do ‘everything we can’ to limit the uncertainty.