ECB: Sustainable Debts Could Help Create More Space for Monetary Policy

2 December 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank on Thursday invoked the limited room to manoeuvre of monetary policy as an argument for sustainable fiscal policies, and in this context expressed support for a more straightforward Stability and Growth Pact (SGP).

In a response dated Wednesday to communication from the EU Commission in October concerning economic governance, the ECB said: ‘The Governing Council stresses the importance of sustainable fiscal positions for price stability and sustainable growth in a smoothly functioning Economic and Monetary Union (EMU).’

‘In addition, in line with the ECB’s monetary policy strategy statement, it recalls that the pronounced trend decline in the equilibrium real interest rate, if persistent, implies that the effective lower bound (ELB) on nominal interest rates will more frequently constrain the conduct of monetary policy’, it continued.

Near the ELB, fiscal policy is more effective than otherwise and thus more important, the ECB said. Although fiscal policy expansion is needed when economic collapse threatens, just as crucial is ‘the rebuilding of buffers once the economy is firmly back on track so as to ensure debt sustainability’, it said.

Fiscal and structural policies can contribute to reversing the decline of the equilibrium real interest rate and thus generate breathing room for monetary policy, the ECB said.

According to the letter, the Governing Council supports a new fiscal framework that is ‘simpler, more transparent and more predictable’, with rules that are ‘less complex and less reliant on the unobservable output gap, which could be operationalised through a stronger focus on an expenditure-based rule that does not rely on annual real-time estimates of such an indicator.’

‘The Governing Council also agrees that a realistic, gradual and sustained adjustment of public debt is important in order to rebuild fiscal space ahead of the next downturn’, it added. ‘The SGP’s debt rule would need to be reformed to guide such an adjustment.’