ECB’s Nagel: Would Caution Against Using Monetary Policy Instruments to Limit Risk Premia
4 July 2022
By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Joachim Nagel on Monday made clear that he regards with great scepticism the possible addition to the ECB’s arsenal of an instrument to prevent fragmentation, and identified various conditions for the set-up and deployment of such an instrument.
In a virtual speech at the Frankfurt Euro Finance Summit, Nagel, who heads the German Bundesbank, framed the discussion of such a tool as a question about whether it was even needed; said that it was up to euro area member countries to support confidence in their debt sustainability; and lamented ‘the impression that fiscal rules will no longer be truly binding in future.’
‘[I]t would be fatal if governments were to assume that the Eurosystem will ultimately be ready to assure favourable financing terms for the Member States’, he said. ‘I would thus caution against using monetary policy instruments to limit risk premia, as it is virtually impossible to establish for sure whether or not a widened spread is fundamentally justified.’
‘For me, it is clear that unusual monetary policy measures to combat fragmentation can be justified only in exceptional circumstances and under narrowly-defined conditions’, achievable only with ‘a clearly defined instrument’, he said.
At the very least, use of such a tool would require that spreads be ‘fundamentally unjustified’, that monetary policy transmission be impaired, and that such impairment be affecting the ECB’s price stability efforts, he insisted.
The Governing Council would decide on the basis of these conditions whether to activate the instrument, which would need to remain absolutely temporary, he said. If these three conditions are satisfied, the ECB’s OMT ‘already exists in principle’ and has been deemed legal, he reminded.
The framework of a new instrument, itself subject to another three conditions, would for starters have to ensure that deployment either avoid affecting the monetary policy stance or, if this is not the case, be accompanied by measures to offset the monetary policy impact, he said.
‘The next condition, relating to our mandate, is that, in order to be compatible with our mandate, any new instrument would have to be justified solely on monetary policy grounds, comply with the principle of proportionality and contain sufficient guarantees to prevent it from entering into conflict with the ban on monetary financing of governments’, he said.
The distinction between the new tool and OMTs would have to be made clear, he said in this context.
A third condition regarding the instrument’s set-up is that member countries remain motivated to pursue sustainable policies, he said.
Turning to current economic developments, Nagel urged prompt monetary policy action. Otherwise, ‘there is a risk that the high rates of inflation will become entrenched’, he warned, a risk that is ‘all the more true given that the price increases are now becoming increasingly widespread.’
Inflation could subside only slowly, and forecasts suggesting medium-term HICP near 2% ‘should not lull into a false sense of security’, he said. ‘[Q]uite possibly, the projection will once again have to be revised upwards next time. So it’s appropriate to exercise caution in this regard, especially since the risks are clearly tilted to the upside – and by that, I mean energy delivery stoppages.’
Following rate hikes on July 21 and September 8, how many more times the ECB has to move hinges on medium-term prospects for inflation, he said. If the outlook does not improve, he said, ‘a more sizeable interest rate hike would be completely appropriate, in my view. We are assuming that further interest rate steps will follow, and that monetary policy normalisation will continue.’
A deposit facility rate of zero obviously cannot be the end of normalisation, he said.
‘Rather, the still very accommodative monetary policy stance should swiftly be abandoned’, he said. ‘However, even that could potentially be insufficient to bring the medium-term price outlook in line with the 2% target. A restrictive monetary policy stance may be necessary to achieve this, at least temporarily.’