ECB’s Weidmann: Need Progress Towards Price Stability for Policy Normalisation

3 May 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank must make progress towards its price stability objective for monetary policy to be normalised, ECB Governing Council member and German Bundesbank President Jens Weidmann said Friday.

In an interview with German daily Berliner Zeitung, Weidmann said that ‘progress towards our target’ was a ‘prerequisite for monetary policy normalisation’, but that in any event, ‘the first step would be to reduce bond purchases before raising key interest rates.’

With uncertainty high, inflation could temporarily exceed projections over the next quarters, but the ECB looks through short-term volatility, he said, which ‘is why the financial markets do not expect a significant tightening of monetary policy in the foreseeable future.’

The ECB’s pandemic emergency purchase programme (PEPP) was ‘clearly linked to the pandemic and will end when it is overcome’, he stressed. ‘However, no one can reliably estimate when this will be the case. In this respect, we are driving by sight.’

Although the pandemic as ‘a classic emergency situation’ justifies asset purchases by the ECB, Weidmann expressed concern about their scope, noting that total Eurosystem holdings of sovereign debt could approach 40% of euro area GDP next year.

His concern when such purchases were initiated a decade ago, ‘that fiscal policy was increasingly embracing monetary policy’, he said, ‘continues to drive me. This blending of monetary and fiscal policy can also make it more difficult for monetary policy to ensure price stability.’

Central bankers ‘should be very clear that we will tighten the monetary reins again if the price outlook requires it, regardless of whether this increases the financing costs of the states’, he said. ‘Otherwise, false expectations might be raised and additional debt taken on, which would further increase the pressure on the central bank.’

The central bank should not ever be presented with the choice of neglecting price stability or potentially triggering a sovereign debt crisis due to higher borrowing costs, he said. ‘That is precisely why we have fiscal rules’, he said. ‘That is precisely why we need market discipline. And that is precisely why monetary policy should not be too closely interwoven with fiscal policy.’

Asked his view on the high level of credit-based financing in the current low-interest-rate environment, Weidmann said the strong growth of the money supply was due to precautionary borrowing and a preference for liquidity by households and firms, but also to monetary policy.

‘Against this background, it is currently being discussed whether the strong money supply growth will contribute to a sustained significant increase in inflation’, he said. ‘I do not see that at the moment.’

Money supply and inflation used to be closely correlated, when the latter was at medium or high levels, he said. ‘At the moment, however, inflation is low and this correlation is not proving to be very meaningful.’

As tighter monetary policy would address this, the question is whether central banks will be willing to do as price stability demands or whether concerns about potential consequences of tightening dominate, ‘so that the reins are tightened too late’, he said.

So-called zombie companies could be less of an issue in this respect, he indicated. ‘In some euro countries, according to studies, the share of these firms has indeed increased during the financial crisis and the subsequent sovereign debt crisis’, he said. ‘But it is not clear whether or to what extent the low interest rates are responsible for this.’

In Germany, he said, the share of such companies has actually decreased. The withdrawal of government support measures will eventually lead to higher insolvencies and thus higher loan defaults, he said, ‘but from today's perspective to an extent that the banking sector in Germany can cope with.’

Models indicate that equity markets are currently characterised by high valuations, he said. ‘What we are seeing right now, especially on the stock markets, is that the assessment of the pandemic there is running ahead of current events’, he said. ‘And if you as an investor assume that interest rates will remain low, you are more willing to pay a higher price for an asset like a share than if you assume that monetary policy is about to normalise.’