MNI INTERVIEW2: ECB Should Keep Trimming Balance Sheet-Kazaks
MNI (RIGA) - The European Central Bank should continue its balance sheet reduction after PEPP reinvestments conclude in January, Bank of Latvia Governor Martins Kazaks told MNI, though he acknowledged the shift would give the Governing Council "a nice case study for the overview” of the 2021 strategy review.
"It's good that we have the now five-year look at our strategy to look at the main policy moves of recent years, and QE and QT are certainly one of the things we should look at,” Kazaks said in an interview in Riga last week.
Interest rates remain the ECB's main policy tool, he added.
While a return to the zero lower bound for rates, which saps the power of monetary policy, is not a central scenario, Kazaks noted that any such development would increase the importance of the debate over the long-term neutral level of interest rates, known by the shorthand r-star.
"If r-star is lower, we are more likely to get into the neighbourhood of zero lower bound. If it is high, then we are a much safer distance in the terms of use interest rates as our instrument," he said "We have been there, done that with [Zero Lower Bound]. But next time it could be easier. Some other countries, like Denmark, have had negative rates and their transmission has been relatively alright.
"The next time that may need to happen, with the according communication, people will act and markets react in a stronger way to the interest rate tool. But there would need to be a very careful discussion about whether that tool needed to be used.”
GEOPOLITICAL RISK
Meanwhile, geopolitical risks are becoming a greater challenge for monetary policy, Kazaks said.
"Looking at geopolitics, uncertainty is still high and risks are still high. Of course, the Middle East is one of the high-risk areas," he said, adding that he was surprised that oil prices had not risen further given escalating conflict.
"Will it remain like that? We don’t know. Part of that is due to the weakness of the Chinese economy,” he said, declining to be drawn on whether a conflict-driven spike in energy prices would have more impact on growth or inflation.
Next month’s U.S. elections also add to uncertainty, he said.
"We can no longer think in singularity of shocks. If shocks happen, they come in a series of shocks and lay over each other. Also, shocks mutate over their lifetime. Supply shocks may turn into demand shocks, as happened with Covid.”