MNI INTERVIEW: "Medium-Term" Has Flexible Meaning-ECB's Kazaks

The European Central Bank's existing policy toolkit will be sufficient to meet its newly-reformed objective for 2% inflation in the medium term, so long as the economy does not deteriorate, Bank of Latvia Governor Martins Kazaks told MNI, adding that the interpretation of medium-term will also depend on conditions.

"If the recovery does not play any ugly tricks, and then we take a look at the current baseline outlook, there is no need to ponder about [other] instruments. The current set of instruments is sufficient," Kazaks said in an interview. "But we are not out of the tunnel yet."

Whether the ECB spends all of the EUR1.85 trillion envelope of its Pandemic Emergency Purchase Programme is also state-dependent, he said.

"If the economy allows, we may use less of it. If things take a turn for the worse, we may increase the volumes and spend more than that. In due time, when we are confident enough where the economy stands and where it goes, then we will inform the markets. We don't want to be jumpy and create unnecessary volatility."

The ECB will also be flexible in its view of the period over which the new symmetrical inflation objective, which allows for a transitory period during which prices increase at a rate moderately above target, will have been met.

"The medium term is not set in stone," Kazaks said. "It's not two years, it's not three years, but it is state-dependent."

NOT FOLLOWING THE FED

Nor does the strategy, unlike the Federal Reserve's, aim to make up for past inflation undershoots, he added.

"It's forward-looking, in that we want to have inflation at 2% over the medium term in the future, not backward-looking in that we failed to have 2% last year so we have to make up for it," Kazaks said.

In last week's unanimous approval of the new strategy framework, governors agreed to take "forceful or persistent" monetary policy measures to avoid inflation undershoots taking root.

Acting forcefully means doing so immediately and on a large scale to calm the markets, Kazaks explained, also noting the importance of the proportionality of any action, something which the ECB has emphasised in line with rulings by Germany's Constitutional Court.

"If it is not sufficient, and you're forced to stay intervening for longer then, it is about persistent intervention. But decisions always come with proportionality assessment. Persistence does not mean the same instruments are used – the set of instruments can be changed when appropriate if their efficacy decreases or they become too costly in terms of their impact on the economy," Kazaks said.

Inflation expectations will be crucial.

"If inflation is somewhat above the target but that during the previous episode inflation expectations have slipped lower and we see a risk of them de-anchoring, then we may accept inflation moderately above the target somewhat longer than otherwise in order to push inflation expectations closer to 2%," he said.

"But when inflation expectations are aligned with the target, we may act much quicker, because there is no risk of expectations de-anchoring. And this is all due to the risks from the effective lower bound."

As shown in the Covid-19 crisis, the ECB is prepared to create new instruments and to act flexibly within its mandate to reach its objective, Kazaks said, although a mix of instruments may prove more effective than an over-reliance on stand-alone tools. The ECB will also consider using existing instruments that have not been used for a long time if necessary and appropriate, he added.