ECB’s Centeno: Yield Curve Control ‘Not the Easiest Way Forward’

3 March 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Mario Centeno on Wednesday expressed doubts about the value of a policy of yield curve control for the ECB.

In an interview with Central Banking, Centeno, according to a text made available by the Bank of Portugal, which he heads, said when asked for his opinion of yield curve control, ‘I think our current instruments are working very well, preserving favourable financing conditions.’

The ECB’s pandemic emergency purchase programme (PEPP) has been effective in maintaining the middle- and long-end segments of the yield curve, one aspect of financing conditions, at appropriate levels, he said.

The euro area GDP-weighted sovereign yield curve is well below its level of prior to the pandemic and the dispersion of 10-year sovereign bond yields across the region is at a new low for the post-2008 period, he said.

All Eurozone member countries can borrow at long maturities under conditions as good as or better than advanced economies elsewhere in the world, he said. This reflects how much accommodation the ECB is providing and will continue to provide so as to offset the impact of the pandemic, he said.

‘Adopting yield curve control implies announcing the target price for government bonds at different maturities’, he said. ‘My opinion is that a central bank can only promise simultaneously specific nominal rates and inflation rates for an extended period of time as long as they are compatible with the long-run real interest rate that clears the market. And that will not be the easiest way forward.’

The recalibration by the ECB of its policy tools last December ‘reflects the evaluation we had on the pandemic and the evolution of the economy at that time’, he said. ‘Now that two months have passed, and there is some perspective to assess it, we are not disappointed about the decision.’

The evolution since then of the pandemic, the public health response and the further economic fallout ‘prove that it was a suitable recalibration of our instruments’, he said. ‘We feel the recalibration was absolutely necessary to fulfil our price stability objective.’

Moreover, he noted, the Treaty compels the ECB to support the EU’s economic policies when this can be done without prejudice to price stability. ‘We think that’s exactly what we have been doing’, he said, observing that size and duration of the PEPP were defined.

‘The PEPP is intended to preserve favourable financing conditions to all sectors of the economy’, he said. ‘This crisis has not been caused by structural weaknesses, but by the nature of the pandemic. That is why we need to monitor a wide set of financing conditions to shield all sectors from an exogenous shock.’

The PEPP and targeted longer-term refinancing operations make it ‘clear that monetary policy is not exhausted’, he said. ‘In fact, it has been a key pillar in addressing the pandemic.’

Centeno, who was previously Portuguese finance minister, dismissed concerns about the growing closeness of monetary policy and fiscal policy, saying the latter was ‘no longer “the only game in town” in Europe, and we should not fear a lack of ECB independence because of it.’

The interaction between the two policy areas is ‘a major leap of integration that many requested for quite some time’ and was mainly enabled by ‘the build-up of confidence during the last three to four years in Europe’, he said,

‘Of course, the magnitude of the crisis also played an important role’, he added. ‘But, over time, we learned that building trust in the Eurozone is the best way to speed up integration and smooth policy interactions.’

Centeno said he was ‘not concerned about fiscal dominance’, highlighting instead the ‘power of monetary and fiscal policy when acting together.’ The value of this ‘interaction effect’ is ‘a lesson learned that should guide our forthcoming decisions’, he said.

As for the possibility that the ECB’s measures could blur the distinction between monetary and fiscal policy, they were effective in supporting growth and inflation as well as ‘crucial in stabilising markets and easing financial conditions’, he said. ‘There are always costs and side effects associated with these decisions.’

That former finance ministers are increasingly represented on the Governing Council ‘should be seen as a natural phenomenon’ that has occurred before, he said. ‘I want to make completely clear this situation did not imperil central banking independence in the past, neither will it do so today. In the Governing Council, we work as a team.’

The ECB’s current definition of price stability ‘creates ambiguity, and it may have led to a perception that the ECB is more tolerant of low inflation than of high inflation’, he said, which in turn ‘may have led to a less successful anchoring of inflation expectations’.

Centeno argued that a ‘simpler, symmetric’ wording such as ‘2% over the medium term’ would be preferable for purposes of communication and anchoring expectations.

‘We can also consider that this change accommodates, to some extent, the fact that the natural rate of interest has gradually declined, which entails smaller room for monetary accommodation because we repeatedly risk reaching the zero lower bound’, he said. ‘This is an interaction affecting our policy framework that we must take care of in the future.’

The adoption by the U.S. Federal Reserve of average inflation targeting is not necessarily an example for the ECB to follow, Centeno indicated, as the need for such an approach to be credible and well understood ‘raises challenges.’

‘On the one hand, it requires more clarity about the length of the make-up window, which is not the case yet, and the horizon over which to reabsorb past deviations of inflation from the target’, he reasoned. ‘On the other hand, having more information comes at the cost of a lower degree of flexibility in future policy decisions.’

If this trade-off could seriously hamper central bank action, he said, ‘especially in the face of uncertain situations in which the central bank may need to follow a different course of action, we must be careful.’

‘In my opinion, it is key to achieve the right balance between clarity and flexibility, which is quite hard’, he added. ‘Another key condition is that long-run inflation expectations must remain firmly anchored.’