MNI INTERVIEW2: ECB In Fiscal Dominance Trap-Kiel's Felbermayr

--ECB May Find It Hard To Withdraw Stimulus, Kiel Institute's Felbermayr Says

By Luke Heighton

     FRANKFURT(MNI) - The European Central Bank might struggle withdraw its

ultra-easy monetary policy for fear of a spike in government debt costs,

trapping it in a situation of "fiscal dominance," the head of top German think

tank the Kiel Institute for the World Economy told MNI.

     "If you look at what ratings agencies say about Italian government debt,

they're very explicit that ECB support is relevant for their rating," said

Gabriel Felbermayr, also a former head of the ifo Center for International

Economics. "If the ECB were to stop those programmes, whatever their names,

whatever the official rhetoric around it, this has the immediate effect of

pushing interest rates up, increasing spreads and threatening the solvency of

Italy, Greece, Spain, Portugal. This threatens their recovery, as it limits the

fiscal space available to them."

     The ECB has "fallen into a situation of fiscal dominance," Felbermayr

continued. "In that sense, central banks are locked in."

     --UNWINDING CHALLENGE

     While the ECB's EUR1.35 trillion Pandemic Emergency Purchase Programme is

designed for "exceptional times", with monetary policy "almost at its limit,"

its use makes it "very clear we're close to monetisation," he said. Unwinding it

will prove a significant challenge.

     "Selling large quantities of bonds fast could cause massive losses on the

balance sheets of those banks that hold large amounts of government debt.

Monetisation per se is not what worries me; it's that the longer you are running

those policies the more difficult it will be to get out of them, and if we do

have some inflationary pressure somewhere - although I don't see it round the

corner right now - the cost of correcting central bank policies will be

enormous."

     With the ECB's strategic monetary policy review expected to start in

September, Felbermayer expressed a preference for target intervals over strict

point targets. "That would be more honest," he said, "The more we think about

inflation targeting, the more we have to acknowledge that we are chasing a

ghost."

     It would also be helpful, Felbermayr said, were the ECB to make its current

role of lender of last resort to European governments "more official."

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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