MNI INTERVIEW: ECB May Be In Liquidity Trap-Bank Of Greece No2

The European Central Bank may have lost its ability to boost inflation via monetary policy, the deputy governor of the Central Bank of Greece told MNI in an interview, saying the eurozone was in secular stagnation and that the only way to boost aggregate demand was via public spending.

"Monetary policy seems to have reach[ed] limits as interest rates are close to the zero lower bound, meaning that monetary policy cannot currently set [the] inflation rate," Theodore Pelagidis said in emailed responses to questions. "In the context of a severe, Covid-led, economic downturn, monetary policy might be ineffective."

In order to reach its target of inflation at below but close to 2% over the medium term, the ECB first needs near full employment, which is impossible without an increase in aggregate demand, Pelagidis said.

"In this case, the one and only tool you have is to increase aggregate demand through a targeted and a well-calibrated fiscal policy," he said.

EU FUNDS VITAL

The official's comments came after Dutch central bank chief Klaas Knot told Bloomberg TV Wednesday that the ECB still has room to cut the deposit rate below the current -0.5% should it need to counter the appreciation of the euro.

The rapid delivery of EU Covid emergency funds was more important than ever, Pelagidis said, warning that financial conditions could worsen further due to cliff effects following the expiration of pandemic loan moratoria and state support measures.

"The ECB's commitment is to preserve favourable financing conditions for all sectors and jurisdictions across the euro area," he said.

The deputy governor saw no danger that ECB monetary policy will come to be dominated by the need to hold down government financing costs.

"The ECB is formally very independent and rock-solid and its mandate sets price stability as its overriding objective," he said, adding that Greece's successful containment of the pandemic is one reason why yields on its debt have remained persistently low.

PEPP FLEXIBILITY

Asked whether he would favour extending the flexibility allowed in the ECB's Pandemic Emergency Purchasing Programme to its older, smaller asset purchase operations, which face restrictions on the quantity and national provenance of bonds that can be bought, he said the ECB would adjust its tools as necessary.

"On the basis of the updated ECB's monetary policy strategy, the Governing Council will recalibrate its monetary policy instruments as appropriate, to identify what is the optimal way to use these instruments assessing also the flexibility of the PEPP program which applies across three dimensions: classes of assets, time, and jurisdictions," he said.

Any eventual decision to phase out the PEPP should be made while ensuring that that recovery is robust, he added.

The Bank of Greece expects a milder domestic contraction over the forecast horizon relative to the euro area, Pelagidis said. The country should see a pick-up to 4.2% growth this year and 4.8% next year, driven by both domestic and external demand, though the coronavirus pandemic is expected to significantly worsen legacy problems inherited from the previous crisis. These include high public debt and unemployment, banks' large stocks of bad loans, and a significant investment gap.