ECB Brief: Panetta Wants Fiscal Authorities to Spend and PEPP Flexibility to Be Retained

28 June 2021

By David Barwick – FRANKFURT (Econostream) – This is a quick take on comments made Monday by European Central Bank Executive Board member Fabio Panetta in a speech at the Conference of the Governors of Mediterranean Central Banks:

• As tendentious as most of his recent monetary policy speeches; Panetta is clearly not one to let pass by unutilised any opportunity to beat the drum for more/longer policy support. Although conceding economic improvement, he hits all the usual notes by reiterating the temporary nature of low inflation, the absence of labour market conditions needed to generate higher inflation and the advisability – as he has stated repeatedly - of not removing policy support too early. But he also urges governments to spend and suggests PEPP-type flexibility may be here to stay.
• Admits brighter economic prospects but says the pandemic shock ‘has not yet been fully reabsorbed’ and ‘attempting to reduce the pace of asset purchases too early would lead to a tightening of financing conditions and a higher pace of purchases later.’
• Expresses a willingness ‘[o]nce we move firmly into the recovery phase’ to ‘start to reorient our policy away from offsetting the pandemic shock’, but reminds in the same breath that attention will then turn to hitting the ECB’s price stability target, which – in a probable reference to the outcome of the strategy review – he says ‘will in turn require us to design our post-pandemic policy framework carefully and calibrate our instruments properly.’
• Says that ‘following many years of low growth and low inflation, both are now picking up’, which he seems to attribute to monetary and fiscal policies ‘working together to stimulate demand’.
• Sees in such cooperation the chance to avoid a situation of weak inflation that monetary policy cannot boost because of already being near the lower bound.
• Identifies as the solution to this trap ‘the confidence that combined policy support will not be withdrawn prematurely.’
• Says that in the US, ‘[s]igns are emerging that the economy could break out of the liquidity trap and that the Phillips curve framework remains valid.’
• Calls ‘persistently tight labour markets’ a condition for sustainably higher underlying inflation; for such labour market tightness, ‘demand will need to remain buoyant enough to test potential even after supply normalises.’
• Doubts that ‘our current policy trajectory’ will strengthen euro area demand enough to ‘test the supply constraints of the economy – beyond short-term bottlenecks’ to the same extent as in the US.
• Predicts that higher euro area inflation this year will be temporary, given the absence of ‘convincing signs that this upward movement will translate into a sustained inflationary process’ and the fact that the conditions for second-round effects ‘are not yet in place.’
• Doubts the persistence of a demand surge, given forced savings are largest among economic agents unlikely to use them, so that the ‘saving rate will normalise, but we do not expect extensive dissaving.’
• Calls the ECB’s forward guidance ‘key for embedding credibility and shifting inflation expectations upwards’ and repeats the commitment to low interest rates and continued asset purchases, which he says ‘creates a natural window for fiscal action.’
• Makes sure fiscal authorities have understood: ‘Governments that spend wisely today can be assured that they will not be penalised with a premature rise in borrowing costs.’
• Again apparently with the outcome of the strategy review in mind, he claims that ‘what was seen as unconventional in the past is now conventional’ in particular the flexibility of the PEPP: ‘We should strive to retain the “unconventional flexibility” that has served us well during the pandemic.’