ECB’s Panetta: Prospects for Inflation Worse Than a Few Months Ago

27 November 2020

By David Barwick – FRANKFURT (EconoStream) – The outlook for inflation has worsened as a result of the second wave of the pandemic and the public health policy response, European Central Bank Executive Board member Fabio Panetta said Friday.

In an interview with Portuguese weekly Expresso, a transcript of which was made available by the ECB, Panetta suggested that asset purchases would be an important part of the ECB’s answer in two weeks, but also described fiscal policy as key.

A calibration of the policy stance serves ‘to reflect our commitment to bring inflation back to our aim,’ he said when asked what form the recalibration could take. ‘We must do this without undue delay, in order to eliminate any possible question marks over our determination to preserve price stability – our primary mandate – and to avoid a disanchoring of inflation expectations: with the second wave, some of the downside risks have materialised and the starting point for the inflation outlook is now lower than a few months ago.’

The data available will drive the decision, he continued, adding that at the last monetary policy meeting, the Governing Council ‘decided that it would not be wise to take a decision before understanding the extent of the new containment measures, their impact on the economy and the fiscal measures that governments would take in response.’

As to the firepower remaining at the ECB’s disposal, ‘[d]ealing with the second wave is all about the right policy mix’, he said. Under the current circumstances, he said, ‘fiscal policy is key. Favourable financing conditions create the best environment for an effective fiscal policy, which in turn creates the conditions for the private sector to also take full advantage of the favourable financing conditions we ensure through our measures.’

That is, fiscal policy has become an important transmission channel, he said. ‘Seen from this perspective, there’s a lot more we can do through a combination of our asset purchase programmes and our measures to support the financing of the real economy through banks and the bond market.’

Asked much later in the interview whether the ECB could be counted on to continue addressing sovereign bond spreads and financial market fragmentation, Panetta’s answer implied that he supported a role for the pandemic emergency purchase programme (PEPP) in the pending recalibration.

Avoiding fragmentation was essential for monetary policy transmission, and this was the basis for the creation of the PEPP, he said. However, the PEPP also exists ‘to support our core price stability mandate’, he continued. ‘The economy is currently subject to lockdown measures and inflation is moving away from our objective of 2%, so we need to take action to stimulate demand and strengthen the inflation path.’

The second wave of the pandemic has ‘clearly’ led to a deterioration of the inflation outlook, he said. ‘It’s also clear that our stimulus so far has not been sufficient to make progress towards our aim in a sustained way’, he said. ‘In spring we reacted quickly and we should do so again.’

The pandemic has entailed ‘considerable downside risks that have threatened to set self-reinforcing recessionary and deflationary dynamics in motion’, and the ECB’s policy reaction will shore up financial markets and the economy, and thus price stability, ‘for as long as necessary’, he said.

Panetta said he was concerned about the possibility of a renewed recession. While progress towards a medical resolution of the pandemic constituted ‘light at the end of the tunnel’, it would take time even in a best case scenario before the vaccines are administered, and perhaps even more time to overcome the uncertainty, he said.

‘In other words, 2021 will still be a “pandemic year”, and we will still have to tread very carefully’, he said. ‘We cannot be complacent. We cannot take the risk of adverse interim scenarios and of letting the consequences of the pandemic last longer without introducing additional policy stimulus, otherwise our production capacity will be hollowed out in the process.’

The ECB ‘cannot take it for granted that things will go as well as expected by financial markets’, as adverse scenarios pose too high a threat and ‘even in the optimistic scenario, inflationary pressures are likely to remain subdued and to recover very slowly’, he said.

Panetta expressed confidence that governments would step up to the plate, saying that they were ‘aware of the need’ to do so, that financing conditions were favourable and that the ECB has explicitly committed itself to keeping conditions favourable.

‘I have no reason to doubt that additional efforts will be made if necessary’, he said. ‘Governments have confirmed this, including those previously reluctant to take part in common responses.’

Like his colleagues, Panetta ruled out the possibility of the ECB cancelling public debt on its books as a violation of the prohibition on monetary financing. ‘And we must remember that all debt is credit’, he added. ‘If we cancel a debt, we cancel the corresponding credit and this could have broader, destabilising consequences. Only growth can protect us from debt.’