ECB’s de Cos: Should Adjust PEPP Purchases to Counter Any Unwarranted Yield Increase

13 May 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank should adjust pandemic emergency purchase programme (PEPP) buying whenever market interest rates increase without a corresponding move of the medium-term inflation outlook to its pre-pandemic path, ECB Governing Council member Pablo Hernández de Cos said Thursday.

In releasing the 2020 annual report of Banco de España, which he heads, de Cos noted the Council’s determination to prevent prematurely tight financing conditions from hindering the economic recovery.

‘In particular, to the extent that increases in market interest rates are not accompanied by a return of the medium-term inflation projection to its pre-pandemic level, purchases under our pandemic programme should be adjusted to counteract this increase’, he said.

In the context of the ECB’s strategy review, the experience of the US ‘illustrates the merits of allowing the inflation target to be exceeded moderately and temporarily in an environment - such as that which has characterised the euro area in recent years - in which inflation is persistently below target and nominal interest rates are close to their lower bound’, he said.

However, he noted, were such a strategy to be adopted by the ECB, it would require that the inflation objective be made precisely 2% and understood symmetrically.

The development of vaccines against Covid-19 ‘has generated a change in expectations that allows us to glimpse a vigorous economic recovery on a global scale in the coming quarters’, he said. However, the recovery’s fragility argues for ongoing policy accommodation in the near term, he quickly added.

To avoid very uneven recoveries internationally, exit strategies should be coordinated and particularly vulnerable countries supported, he said.

De Cos called for ‘a permanent and sufficient macroeconomic stabilisation mechanism with tax and borrowing capacity’ in the euro area. ‘In addition, fiscal rules need to be reformed.’

He continued: ‘On the one hand, the secular decline in long-term interest rates means that higher debt levels can be maintained without compromising public finances in the long run, provided that potential growth has not been reduced in parallel. On the other hand, a new framework is needed in which national and European fiscal authorities complement each other.’

‘National authorities should focus on debt sustainability, while supranational authorities would respond to tail events and adjust the fiscal policy stance at the aggregate euro area level’, he said.