ECB’s Nagel: Tighter Monetary Policy Likely to Dampen Growth, But Not Tightening Is No Alternative

23 September 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Joachim Nagel on Friday said that while higher borrowing costs would temporarily slow economic growth, monetary policy tightening was unavoidable.

In a speech at Switzerland's Lucerne University, Nagel, who heads the German Bundesbank, said that monetary authorities could leave ‘no doubt’ that they take seriously and are up to the ‘severe test’ of high inflation.

Following the ‘significant’ hikes of July and September, he said, ‘[t]here are prospects of further tightening steps and in my view they will have to come.’

The tightening of monetary policy was ‘likely to dampen growth temporarily’, he conceded. ‘But doing nothing and letting things take their course is not an alternative.’

Nagel called for an end to the ECB’s asset purchases ‘swiftly when they have fulfilled their purpose.’

Referring to the potential of the Transmission Protection Instrument (TPI) to interfere with market functioning in the context of purchases of specific sovereigns’ debt, Nagel observed that ‘the focus on bond yields of individual countries is obviously a tightrope walk’ between the need to keep the transmission mechanism working and the undesirability of squelching market signals.

‘For this reason, the TPI contains safeguards’, he said. The Governing Council will ‘stringently and consistently’ verify that member states for which the TPI is being activated are on a sustainable fiscal and economic path, he said.

‘However, I would like to emphasise once again that the objective of TPI and OMT is precisely not to influence government bond yields at will and thus to cancel out price signals’, he said. ‘Rather, the aim is merely to eliminate yield components that cannot be reconciled with the fundamentals of the member state in order to ensure the functioning of the transmission mechanism.’

‘Since such situations are fortunately rare and unfortunately not easy to detect, a Governing Council decision to activate the TPI should be based on a comprehensive assessment of market and transmission indicators so that transmission disturbances are sufficiently evidenced’, he said.

Nagel said it was important to him that if the TPI’s activation is under consideration, ‘then we must be able to convincingly prove that we are correcting a mistake made by the markets that severely restricts monetary policy.’