ECB Brief: Reaction to Knot Comments Shows Difficulty of Taking Back Policy Gifts

12 April 2021

By David Barwick – FRANKFURT (Econostream) – Of the many sentiments expressed by European Central Bank Governing Council members in recent days, one from Dutch National Bank head Klaas Knot has generated reactions that underscore particularly well the difficulty the ECB could face in taking back anything it has given.

Knot’s foray, launched on Wednesday, was that ‘[i]f the economy develops according to our baseline, we will see better inflation and growth from the second half onwards. In that case, it would be equally clear to me that from the third quarter onwards we can begin to gradually phase out pandemic emergency purchases and end them as foreseen in March 2022.’

Knot was backed by Austrian National Bank chief Robert Holzmann, who affirmed with respect to pandemic emergency purchase programme (PEPP) purchases that ‘the decision for the third quarter we’ll make at the end of the second quarter, and hopefully by that time there will be a possibility to reduce again the purchases.’

Most Council members’ contributions to the discussion spoke less directly to the question of whether the next quarter might be the moment to scale back PEPP purchases. Rather, they – like Banca d’Italia’s Ignazio Visco - reiterated the watchword that ‘measures have to be maintained as long as necessary … perhaps a little bit postponing the exit is less worrisome than winding down too early.’

One exception was Bank of Greece Governor Yannis Stournaras. While every bit as convinced as his dovish colleagues of the general urgency ‘to keep monetary accommodation in place’, Stournaras also tackled Knot’s suggestion head-on.

The third quarter would be ‘too soon’ to start phasing out PEPP purchases, he said. ‘We don’t have any evidence that things will turn so benign in the third quarter.’

‘What we have agreed in the Governing Council is that we’ll do whatever it takes with our pandemic programme to make sure that there will be favourable financial conditions’, he continued. ‘And we’re still falling below our inflation targets.’

The ‘blip’ in inflation seen occurring this year is ‘for one-off reasons’, he said. ‘But the inflation outlook remains still very weak compared to our target. So I don’t see any reason why we should withdraw the monetary stimulus we are providing now.’

The proper time to commence such a withdrawal would be ‘[w]hen we have concrete evidence that inflation is coming up on a sustainable and permanent basis’, he said. ‘The pandemic programme runs in principle up to March, but if needed, it can be extended.’

It seems at least a bit premature to rule out today - precisely as the average pace of vaccination in Europe is picking up and the massive US stimulus starts to unfold an impact expected to be felt here - the possibility that developments in 3Q – so up to five and a half months from now - could warrant any tightening of the monetary reins.

While it is no secret that Knot takes a relatively dim view among Council members of massive asset purchases, he made clear that the decision will be data-driven (‘[i]f the economy develops according to our baseline’), whereas Stournaras appeared firmly pre-committed to leaving in place or even increasing monetary accommodation.

Moreover, Stournaras seemed implicitly to conflate the impact of the pandemic on inflation and the projected path of inflation independent of the pandemic. The weakness of inflation even before the pandemic is not what gave rise to the PEPP, whose purpose has been to protect monetary policy transmission during the crisis and offset the effects of the pandemic on inflation. ‘Regular’ asset purchases were already being conducted when the pandemic struck to address persistently weak inflation prospects, and will continue when the PEPP has outlived its usefulness.

As such, the PEPP is considered temporary by most Council members, hawk or dove, and its life span is clearly tied to the duration of the pandemic; the ECB would otherwise risk being unable to justify it. As Executive Board member Isabel Schnabel said on March 16: ‘When we judge the pandemic crisis phase to be over, and when we have managed to counter the shock to the inflation path, it will be time to end it.’

ECB President Christine Lagarde was referring to this limited role of the PEPP when she said in an interview on Friday that the ECB ‘may well reduce the pandemic emergency programme when the time comes, when we see the crisis coming to an end. Yes, but that’s the emergency programme. We also have another programme of asset purchases.’

She seemed to indicate that the current timeline remained valid, though she hedged her bet. ‘We’ve assumed that it would be March – up until now’, she said. ‘If it needs to be extended because the Governing Council determines that the crisis is likely to last longer, we will extend it.’

That Lagarde couldn’t or wouldn’t find somewhat more forceful, less guarded language will justifiably leave observers unsure, but at a time of uncertainty is also not wholly unexpected. However, it may be a foretaste of just how difficult it will be, when the time comes, for the ECB to take away any of the benefits its policy actions have given.