ECB’s Schnabel: Vaccine News Is ‘Light at the End of the Tunnel’

24 November 2020

By David Barwick – FRANKFURT (EconoStream) – The recent news regarding a medical solution to the pandemic is ‘light at the end of the tunnel’, European Central Bank Executive Board member Isabel Schnabel said Tuesday.

In a speech for a Bank of Finland monetary policy webinar, a text of which the ECB provided, Schnabel primarily discussed how the pandemic would affect views of price stability under low inflation, of monetary policy’s impact near the effective lower bound, and  of how policy instruments are designed.

‘Although recent news on the effectiveness of vaccines provides light at the end of the tunnel, significant uncertainty about future income prospects can be expected to prevail for some time, also because the pace of the rollout of vaccines and their acceptance among the public remain uncertain’, she said.

This uncertainty ‘is likely to weaken the willingness and ability of firms and households to take full advantage of historically loose financial conditions’, she said, preventing monetary policy from acting with full force.

As a result, she said, fiscal policy is ‘indispensable in order to sustain demand and mitigate the long-term costs of the crisis.’

Still, this is not to say that the ECB is powerless, she said, and currently expansionary financing conditions are an important source of support for the economy.

‘Preserving them for as long as needed will be essential to ensure that inflation returns to our aim in the medium term’, she added.

Schnabel suggested that interest rate changes are less effective when rates are already low. In addition to possibly non-linear macroeconomic effects of rate changes that ‘could affect the extent to which central banks can bring future activity into the present’, she said, policy rate transmission to bank lending rate is weaker near zero and there is the problem that ‘people often cannot distinguish between real and nominal developments and may therefore react less to changes in real interest rates than what our models would tend to suggest.’

Concern about the decline in recent years of market-based inflation expectations in recent years, which has tightened financial conditions by raising real expected interest rates, may not be entirely warranted, she indicated.

This is partly because much of the decline is due to a fall in the inflation risk premium, correcting for which yields ‘much more aligned’ expectations when comparing market-based indicators with those from surveys, she said. Another reason is that option prices set on financial markets may not be very indicative of future inflation, she said.

‘This raises the question of whether inflation expectations of households and firms may be more relevant than those of the market for shaping macroeconomic outcomes in line with the expectations hypothesis’, she said.