ECB’s Weidmann: Monetary Policy Needed to Act, Given Inflation Outlook

16 December 2020

By David Barwick – FRANKFURT (Econostream) – Monetary policy in Europe needed to take action against the recent pandemic-related worsening of inflation prospects, European Central Bank Governing Council member Jens Weidmann said Wednesday.

In a virtual speech for the Humboldt-Universität zu Berlin, Weidmann, who heads the German Bundesbank, nevertheless emphasised his sceptical attitude regarding government bond buys by monetary authorities.

‘There was certainly a need for action in terms of monetary policy recently’, he said. ‘Because according to our forecast, medium-term inflation in the euro area has decreased again due to the pandemic.’

Weidmann made clear that his ‘fundamental skepsis towards comprehensive sovereign bond purchases’ remained, citing the danger of a blurring of the line between monetary and fiscal policy and asserting that the risks ‘weigh heavily’.

‘On the other hand, it is undisputed that bond purchases can be a legitimate and effective instrument of monetary policy’, he said. It comes down to balancing the justification for such programmes against unintended consequences.

‘Decisive’ in his view, Weidmann said, was that central banks do not hold ‘too large’ a share of sovereign bonds, lest monetary authorities acquire ‘dominant market influence’ and risk premia disappear.

‘That further weakens market discipline’, he said. ‘This problem above all is intensified by the most recent increase in the PEPP [pandemic emergency purchase programme].’

Weidmann reminded of the importance of limiting the PEPP to the crisis, whereas net purchases under the programme are now to run at least through March 2022. ‘We have to pay attention that the monetary policy emergency measures don’t become a permanent institution,’ he said. ‘They have to be unwound again after the crisis.’

‘Something else must be equally clear: If the price outlook requires it, monetary policy as a whole must be normalised’, he continued. This however could be problematic, as ‘higher interest rates are unlikely to be to everyone's liking.’

Recent calls for the Eurosystem to cancel sovereign debt, while ‘extreme and absurd’, underscore the threat of fiscal dominance, he said.

In general, the impact of the pandemic on inflation prospects means that ‘[a]n expansive monetary policy course is important’, he said. Price stability also implies a financial system with enough liquidity to support the economy, he added.

Though short-term output may undershoot projections, progress towards a vaccine should let the recovery pick up steam starting in spring, he said, so that the German economy would return to pre-pandemic levels at the start of 2021.

Still, uncertainty remains high and a less optimistic scenario involved a restoration of pre-crisis output levels only end-2023, with ‘considerable long-term damage’, he said.

Weidmann reiterated his endorsement of ‘massive fiscal policy support’, arguing that the economic collapse would be worse otherwise.