ECB’s Wunsch: If Fiscal Policy Stays Loose, Monetary Policy Would Have to Do More

27 May 2023

By David Barwick – DUBROVNIK, Croatia (Econostream) – European Central Bank Governing Council member Pierre Wunsch on Saturday warned that continued expansive fiscal policy would require a larger reaction from monetary policy.

In remarks at the Dubrovnik Economic Conference of the Croatian National Bank, Wunsch, who heads the Belgian National Bank, said, ‘On fiscal of course, we would hope and expect some consolidation. … If fiscal remains supportive, then monetary policy would have to do more to get inflation under control.’

‘This is going to imply higher interest rates and, at the end of the day over the medium term, higher deficits because of the debt burden and a higher risk of fiscal dominance’, he added.

On average in Europe, a certain amount of fiscal consolidation would occur, he predicted. However, he said, the issue was also about individual countries rather than just the average.

‘And there I’m much less optimistic that we are not going to be faced with some kinds of fiscal fragmentation and basically some countries having fiscal policies that are not really sustainable’, he said.

The euro area was not currently subject to fiscal dominance in strict terms, he made clear.

‘I mean, we’ve hiked 400bp, and we might … have to do more’, he said. ‘So, this is not fiscal dominance. I’m not saying that.’

‘But what I’m saying is that, you know, we felt more comfortable first doing the TPI’, he elaborated. ‘We’ve got PEPP flexibility. We know that there is a risk that in some countries … the fiscal situation is maybe not going to improve enough.’

The region is thus ‘flirting with some weak form of fiscal dominance’, he criticised. ‘We are not in a situation … where we could operate in terms of monetary policy completely without thinking about the fiscal implications. This is not okay, and this is again one more argument for why fiscal positions need to be improved in all countries that have high debt and deficit levels.’

Wunsch, who reiterated that interest rates were ‘still quite low in real terms’, also said that monetary policymakers had ‘got some more ground to cover.’