ECB Insight: If PEPP’s Flexibility Ends With It, ECB Will Need to Signal Ability to Handle Problems

29 September 2021

By David Barwick – FRANKFURT (Econostream) – As the emergency phase of the pandemic marches on towards its end, perhaps the toughest debate awaiting the European Central Bank’s Governing Council is that about how much of the pandemic emergency purchase programme (PEPP)’s vaunted flexibility can and should be retained beyond the life of the PEPP.

Econostream has shared its views on the subject previously, most recently earlier this month. While remaining sceptical of the likelihood of a wholesale inheritance by the asset purchase programme (APP) of the PEPP’s characteristics, based on ongoing dialogue with people with insight into the looming debate we see no way around a strong signal that the euro area’s monetary authorities will continue to be able to do their job in a way up to whatever circumstances may arise.

The fact that, past the initial crisis, the ECB has generally been able to purchase bonds according to the key used to calculate national central banks’ respective share of the ECB’s capital may not carry much weight in the discussion, even if Vice President Luis de Guindos in a German newspaper interview two months ago highlighted this.

‘Yes, now they are buying according to the capital key and there is no problem’, a person Econostream spoke to said. ‘But why is there no problem? Because the markets know that at any time they can deviate from the capital key. And so the signal is very strong because the market is reassured beforehand.’

If told explicitly that the ECB would respect the capital key, markets could be less reassured, he said, ‘knowing that if something happens in Greece or Italy, it needs a new decision with all the mess around that, because of political pressure and North versus South and so on.’

The entire time such a decision by the Governing Council remained outstanding, the situation would be likely to worsen, giving rise to financial stability concerns, he observed.

Allowing such a situation to emerge in the first place might be seen at the ECB as being at odds with its new strategy, the statement of which says the new framework reflects, among other things, ‘the recognition that financial stability is a precondition for price stability.’

‘We have to be careful about contributing in a certain sense to problems in some jurisdictions and generating there and across the Eurozone financial stability problems that may then cause an economic slowdown and endanger the price stability objective’, he said. ‘So there is a consistency debate there, too.’

As we have argued previously, a transfer to the APP of the PEPP’s flexibility could open the ECB to charges of a lack of proportionality and even invite legal challenges, a point Econostream’s interlocutor readily conceded.

‘There are pros and cons. That’s why I say that this exercise will be very delicate and very difficult’, he said. ‘Everything has to come onto the table, but at the end of the day, I would want one way or another to make sure the ECB keeps sufficient flexibility to counter tensions that may arise in certain jurisdictions.’

An additional factor of high relevance is that the exit is occurring during a period of elevated uncertainty about how the economy will develop and what is in store on the inflation front, he observed. ‘There are many things that you cannot compare to previous periods’, he said. ‘In such uncertainty it’s wise to keep all flexibility with you.’

A possible compromise would be a statement by a united Governing Council declaring that authorities ‘stand ready to maintain the efficiency of the transmission process in all jurisdictions at all times’, he suggested. Whether this would be sufficient to forestall difficulties in the more vulnerable member states would remain to be seen, however.

The more pressing question for now is the practical matter of whether such a statement by itself would be sufficient to assuage the concerns of those Governing Council members from the area’s more vulnerable economies and others who share their hesitance to leave the security of the PEPP behind.