ECB’s de Cos: Should Consider Giving Future Purchase Programmes Some of PEPP’s Flexibility

27 July 2021

By David Barwick – FRANKFURT (Econostream) – The value of being able to conduct asset purchases with the flexibility of the European Central Bank’s pandemic emergency purchase programme (PEPP) suggests giving consideration to equipping future purchase programmes with a degree of flexibility as well, ECB Governing Council member Pablo Hernández de Cos said Tuesday.

In an interview with Bloomberg, de Cos, who heads Banco de España, said that ‘although there is some diversity of views’, economists in general recognised that the ECB’s strategic review reflected the ECB’s determination to pursue price stability despite very low natural interest rates and official interest rates near the lower bound.

‘Against this backdrop, the ECB’s announcement that a particularly energetic and persistent response is needed to prevent a persistent downside bias to inflation in the face of adverse shocks is especially important, and this may also imply that inflation could temporarily remain moderately above the target level of 2%’, he said.

De Cos lauded the ECB’s new forward guidance as ‘much more precise and … designed to prevent premature tightening of our monetary policy that could jeopardise our commitment to symmetry with the inflation aim.’

The new wording ‘underlines our commitment to maintain our persistently accommodative monetary policy stance to meet our inflation target’, he said. ‘And, again, this could also entail a transitory period in which inflation is moderately above target.’

Asked what monetary policy instruments the ECB would most probably rely on to restore price stability, de Cos answered in broad terms that the new strategy and new forward guidance would help, and that the PEPP had ‘taught us some important lessons which will be useful when we seek to enhance the effectiveness of our future asset purchases.’

‘In any event,’ he added, ‘our new strategy makes it crystal-clear that we … will consider new policy instruments, as and when necessary, to achieve our price stability objective.’

The requirement imposed by the new forward guidance that that underlying inflation be ‘sufficiently advanced’ means that the ‘more stable components’ of overall inflation should be converging on the 2% target along with overall inflation itself, he explained.

While it would be ‘rather impractical to set an ex ante quantitative reference for all or a subset of these indicators’ of underlying inflation, he said, ‘what is important is to ensure that, overall, these indicators should offer a clear signal of robust and durable recovery in the medium-term price trend that is compatible with our objective.’

De Cos endorsed the view that ‘well ahead of the end’ of the ECB’s projection horizon meant 12 to 18 months, but rejected objections raised by other Council members to the new forward guidance, saying that ‘forward guidance is state contingent, so it demands a commitment to reacting in a certain way to a certain inflation outlook, not a commitment to setting policy rates at a certain level unconditionally.’

Decisions are ‘subject always to a rigorous proportionality assessment’ and the new guidance ‘can show us the way to an orderly process of policy change’ in the event that ‘the outlook improves more than anticipated’, he said.

The ECB’s medium-term orientation gives it the flexibility to consider financial stability issues as well as employment, he observed, so ‘I do not think it is really necessary to add any escape clause.’

As usual, de Cos showed no inclination to discuss the future of the PEPP, calling it ‘still too soon to say’ when such a discussion might start.

‘We link the end of the PEPP to the course of the pandemic and its effects on the economy’, he said. ‘Against a background of still very high uncertainty as at present, we should not get ahead of ourselves with this discussion. In any event, our decision will depend on how the health crisis evolves, on financing conditions in the euro area economy and on the inflation outlook.’

Asked how the asset purchase programme (APP) should be modified to account for the ending of PEPP, de Cos focussed instead on the need for the PEPP to ‘remain in place while the pandemic and its effect on the economy persist.’

After the pandemic, the APP and forward guidance would ‘continue to be fundamental instruments’, he said. The ‘main lesson to be drawn’ from the experience with the PEPP ‘is that flexibility in the distribution of asset purchases has notably increased not only the effectiveness but also the efficiency of our asset purchases.’

‘It would therefore be desirable to discuss the possibility of our future purchase programmes retaining some of the flexible elements of the PEPP’, he added.