ECB’s Weidmann: Needed to Act on Dec 10, but Must Not Overbuy Govt Debt

7 January 2021

By David Barwick – FRANKFURT (Econostream) – The inflation outlook demanded monetary policy action on December 10, but central bankers should take care not to wind up holding too much government debt, European Central Bank Governing Council member Jens Weidmann said Thursday.

In a speech at an event of a German political party, Weidmann, who heads the German Bundesbank, urged monetary authorities to establish beyond any doubt that they would tighten policy as soon as inflation prospects warranted it.

In view of the most recent inflation projections of the ECB, ‘certainly there was a need for monetary policy action’, he said with regard to the Governing Council’s December 10 policy meeting. The Eurosystem must take care, however, not to hold too large a share of sovereign debt, lest market discipline be undermined, he said.

Moreover, emergency measures must not become permanent, he said, and when inflation prospects warrant it, monetary policy must tighten. Such normalisation cannot founder on ‘individual member states’’ indebtedness, thus giving way to fiscal dominance, he said.

Weidmann explicitly noted the high debt-to-GDP ratios of Italy and Spain. ‘Precisely highly indebted member states can be susceptible to interest rate hikes’, he said. Although higher official borrowing costs do not pose an immediate threat, ‘[d]angerous is a combination of high debts and weak growth’, he said.

So as to make clear that they are deaf to political pressure, central bankers should thus leave no doubt about their willingness to tighten policy when justified, he said.

Weidmann reiterated his ‘fundamental scepticism’ regarding central bank purchases of sovereign debt, citing again the risk of a blurring of the line between monetary and fiscal policy. Such purchases ‘can indeed be an effective and legitimate tool of monetary policy, but have to be reserved for exceptional situations’, he said.

The pandemic was and remains such a situation, he added. ‘It’s obvious that the economy can only recover permanently and completely when the pandemic has been overcome', he said.

Although the recent evolution of the pandemic has been less favourable than expected, ‘surprisingly favourable’ data and sentiment indicators the last couple of months are a more positive counterpoint, he said, so that an economic collapse like that of last spring is unlikely.

In particular, he noted, manufacturing is now supporting economic developments and is barely affected by current containment measures, while foreign demand for German-made products is healthy.

Weidmann predicted that widespread immunisation would lead to a ‘gradual’ normalisation during 2021, and said that this was why, despite high uncertainty, the Bundesbank was sticking to its December forecasts, according to which the German economy would expand by 3% and 4.5% this year and next, respectively.

As before, he expressed support for the increase in German government debt as warranted by circumstances. He urged that measures taken to counter the crisis be limited in time so that deficits could be reduced and the government be in a position to handle the next crisis.

Turning to the ECB’s ongoing strategy review, Weidmann advocated an explicitly symmetrical inflation target as ‘clearer and easier to understand as the current formulation’, but warned against creating the impression that monetary policy could steer inflation with precision.

The medium-term orientation of monetary policy should be kept, he said.