ECB’s Lane: Recovery Path Will Be Long and Fraught With Risks

26 November 2020

By David Barwick – FRANKFURT (EconoStream) – The path to economic recovery remains long and subject to risks despite progress with regard to vaccines against Covid-19, European Central Bank Executive Board member Philip Lane said on Thursday.

In a speech at Trinity College Dublin, a text of which the ECB made available, Lane, who is also chief economist, struck a noticeably more dovish tone than he had in an interview published just nine days previously, warning of the dangers of failing to remedy a more sustained period of yet lower inflation.

‘While the recent news on vaccines is very welcome and reduces the likelihood of the most severe scenarios, the current surge in infections and the re-imposition of containment measures serve as warning signals that the recovery path will still be long and fraught with risks’, he said. ‘Economic developments are likely to be unsteady and uneven across countries and sectors for some time to come and remain subject to elevated uncertainty.’

At its December monetary policy meeting, the Governing Council would recalibrate its instruments ‘to ensure that financing conditions remain favourable to support the economic recovery and counteract the negative impact of the pandemic on the projected inflation path’, he said.

Lane cautioned that ‘[t]olerating a longer phase of even lower inflation … than originally envisaged would be costly and risky’, because the resulting higher expected real interest rates would restrain recovery and investment and because ‘it would contribute to a downward drift in inflation expectations that might become entrenched.’

The latter risk must be taken particularly seriously, given the long period during which inflation has already undershot the ECB’s objective, he said. That makes it essential to anchor expectations via the commitment ‘to offset the negative pandemic shock to the inflation path and ensure convergence to the inflation aim over the medium term’, he said.

This implies the primacy of restoring inflation to the path it had been expected to follow prior to the pandemic, he said. Adjusting the policy stance to deliver the requisite financing conditions would accomplish this while supporting inflation expectations that are consistent with the medium-term objective, he said.

The ECB’s commitment to favourable financing conditions would additionally bolster confidence, hinder adverse feedback loops between the real economy and financial markets, facilitate fiscal support and prevent a premature steepening of the yield curve as potentially positive medical developments occur, he said.

Averting feedback loops is a ‘central task’, he said, and while these have been avoided thus far, ‘there are some worrying signals in recent survey data.’ In this connection, Lane cited the bank lending survey and the Survey on the Access to Finance of Enterprises.

The two surveys ‘signal some risk of a mutually-reinforcing adverse loop’, he said. Banks may interpret weaker demand for loans as a negative economic indicator, while firms may take tighter conditions to corroborate their economic concerns, he said. A weakening of household spending would reinforce this, he added.

Another feedback loop could occur if governments fear they cannot act fiscally without raising concerns about their fiscal soundness, as ‘the associated deterioration in the macro-financial environment could indeed validate an increase in sovereign risk premia’, he said.

Like his colleagues, Lane extolled the virtues of a strong fiscal policy response in the current environment, affirming ‘a clear lead role for fiscal policy in driving overall demand and addressing sectoral asymmetries.’

In other comments, Lane called the ECB’s pandemic emergency purchase programme (PEPP) and the easing of conditions for targeted longer-term refinancing operations (TLTROs) ‘the two cornerstones of our monetary policy response: their design and calibration are directly linked to the evolution of the pandemic and its impact on the monetary transmission mechanism and the economic outlook.’