EXCLUSIVE: ECB’s Šimkus: PEPP Flexibility Doesn’t Mean Another Programme Must Also Be Flexible

28 July, 2021

By David Barwick – FRANKFURT (Econostream) – The importance of flexibility for the European Central Bank’s pandemic emergency purchase programme (PEPP) does not necessarily mean another asset purchase programme must be endowed with this feature when the PEPP ends, according to ECB Governing Council member Gediminas Šimkus.

In an interview with Econostream, Šimkus, who is Chairman of the Board of the Bank of Lithuania, said that before the end of the current year, the Governing Council would likely need to clarify its understanding of the pandemic crisis phase, and would in any case consider the PEPP’s future.

The expectations expressed by participants in the ECB’s June Survey of Monetary Analysts were not in line with the ECB’s reaction function as the latter was even before the outcome of the strategy review, Šimkus said.

The issue of how the ECB would respond post-PEPP to market fragmentation that threatens transmission was ‘a very good question’, he said. The PEPP’s flexibility has made it a very effective way to reduce fragmentation, ‘[b]ut once the risk of fragmentation is no longer a matter of concern, why do we need to transfer the specific feature of flexibility into other asset purchase programmes that have different purposes?’

‘So, yes, flexibility was an important factor in the PEPP’s success, but this does not automatically mean that we should transfer this characteristic to another asset purchase programme’, he said. ‘[W]e’ll have to see whether we need a measure with such flexibility beyond March 2022, because we’re going to have it at least until then anyway.’

Šimkus said he was also ‘not thinking that we will need to have a new instrument with this kind of flexibility.’ The point was rather the ability to ‘act very forcefully with a targeted measure’ as with the OMT and the PEPP. ‘So here I think what’s important is that the Eurosystem is ready and can act forcefully to address fragmentation when it’s needed to ensure the transmission of monetary policy’, he said.

When the crisis phase would be over and how this was to be determined was ‘a very important question, because it relates closely to the PEPP’, he said. ‘This is something we need to work on in the Governing Council, probably this year,’ given the present time horizon of the PEPP, he said. ‘So we obviously need to have some clarity on how this crisis phase is defined, because March is a sort of deadline by which we need to have a clearer picture. This is something that the Governing Council needs to define.’

For now, however, it remained ‘a bit premature to talk about this’, he said. ‘We will certainly discuss asset purchases in the Governing Council later this year when we debate about the PEPP. The emergency aspect is part of this, along with the implications for our policy stance and the need to avoid potential cliff effects. But most importantly, in all these discussions, we should make sure that inflation robustly converges eventually toward our 2% target, and premature tightening should be avoided.’

Šimkus took issue with the results of the June ECB Survey of Monetary Analysts, according to which median expectations were for the deposit facility rate to be increased in May 2024.

‘Even before the change in the strategy, I did not think that these expectations were in line with our monetary policy reaction function’, he said, observing that median expectations of HICP in the same quarter had been 1.7%, while in the long-term they were 1.8%.

With forward guidance now incorporating the changes to the framework brought about by the strategy review, ‘[w]e intend to keep key ECB interest rates at their present or even lower levels until we see inflation reaching 2% well ahead of the end of our projection horizon’, he said.

‘From all this, it’s quite evident that these expectations are not in line with our monetary policy reaction function, and I think the new formulation of our forward guidance will help markets better understand that our monetary policy will be patient and persistent in order to eventually converge to 2% inflation over the medium term’, he said.

The ECB’s willingness to overshoot on a moderate and transitory basis ‘expresses the idea that monetary policy will be patient’, he said. ‘How do I understand “moderately” and “transitory”? We don’t have specific numbers behind these terms. Probably this is something to be seen once it becomes an issue. It’s not about the number at a given moment; it’s about the intention.’

Šimkus indicated that he did not share the view expressed in the June Governing Council meeting that the high inflation in other advanced economies further along in the recovery ‘could be a harbinger of developments in the euro area further down the road’, as the account of that meeting reported.

‘No, because there are differences about the euro area that will persist’, he said, pointing to high unemployment. ‘Possible differences in fiscal policies going forward also matter, and yet another factor is that inflation expectations are still below target here, which is different from the situation in the US.’

Although the inflation outlook for the euro area has improved, he said, ‘even if we see a pick-up in inflation this year, my view is that it’s transitory and inflation will fall back below 2%.’

The risk assessment of the monetary policy statement was ‘quite balanced, with the references to both upside risks and downside risks’, he said. ‘And I agree with the assessment of broadly balanced risks to medium-term growth. We have very high uncertainty.’

The coronavirus was a source of ‘exogenous uncertainty’ and ‘unpredictable’, with no ruling out yet ‘another Greek letter variant later this year’, he said

‘I really think that until we beat the virus, or at least know how to live with it, there will always be some doubts and risks that need to be stressed’, he said.

Šimkus endorsed the ECB’s newly worded forward guidance as a decision that ‘gives us a lot of credibility that our monetary policy will be patient and persistent, and will not over-react to temporary factors.’

If in 2024 price stability has still not been achieved in the euro area, ‘then we are doing something wrong and need to think how we can strengthen our toolkit or change something’, he said. ‘Otherwise, we are not delivering, basically.’