ECB’s Panetta: Failure to Withdraw Fiscal Energy Support Measures Could Worsen Inflation

20 September 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Fabio Panetta on Wednesday warned that inappropriate fiscal policies had the potential to support demand so much that monetary policy might need to react.

In a speech posted to the website of the ECB, Panetta said that ‘it has become necessary to withdraw fiscal energy support measures in a timely manner.’

‘Failure to do so could create a demand impulse that would exacerbate inflationary pressures, which would in turn trigger a monetary policy response’, he said. ‘This would be highly inefficient, akin to giving with one hand and taking away with the other.’

Monetary and fiscal policy should work together when the situation demands it, he said. The interaction between them should reflect economic circumstances rather than ‘rigid, predetermined rules’, he said.

For this to occur, fiscal governance has to have a degree of flexibility, such as ‘when we allow escape clauses that temporarily freeze the implementation of European fiscal rules to be activated in exceptional circumstances’, he said.

Ideally, fiscal policy would work to smooth out the ups and downs of the economy and at the same time promote investment to boost potential growth, he said.

‘And for fiscal policies to contribute to both price and macro-financial stability, they need to complement monetary policy when needed’, he said. ‘Price stability, in turn, supports fiscal sustainability by keeping government financing costs low over time.’

Panetta renewed his call ‘for an enhanced framework to monitor and steer the aggregate fiscal stance of the euro area, which is a fundamental requirement for smooth monetary-fiscal interactions in our region.’

A crucial aspect of this was a ‘properly designed permanent central fiscal capacity’, he said. The absence of this would leave euro area governance incomplete and lead to a deficit of fiscal credibility, he said.

‘As I have argued elsewhere, it is an illusion that EMU can function smoothly without a centralised fiscal capacity’, he said. ‘It is now time to address the imbalances in the institutional framework of the monetary union, whereby a single monetary policy coexists with a fiscal policy that is fragmented across national lines.’

‘Moreover, without a permanent common fiscal capacity with a borrowing function, balancing fiscal sustainability, stabilising public finances and addressing Europe’s substantial investment needs will be impossible’, he continued. ‘The weakness of public investment in the euro area, particularly in the years following the great financial crisis, is a case in point.’