Mersch rejects US-style inflation-targeting

ECB's man for all seasons sets down his legacy

Yves Mersch, the European Central Bank’s long-time man for all seasons, has obdurately defended the bank’s price stability objectives, rejecting a US-style average inflation-targeting regime which ECB hawks regard as potentially destabilising. Mersch is the sole member of the ECB’s 25-person decision-making governing council to have held his post continuously, spanning a wide variety of functions, since the ECB’s establishment in 1998. The former Luxembourg treasury director and central bank governor helped negotiate the 1991-92 Maastricht treaty setting up the single currency.

In a publicly broadcast 16 November OMFIF interview marking his departure next month after eight years on the ECB’s board, helping set his legacy across a wide range of themes, Mersch

  • held out the prospect of further monetary easing at next month’s final 2020 policy-making council meeting, based on the ECB’s foremost existing tools of asset purchases and extra liquidity operations to help banks
  • ruled out the ECB on 10 December testing market appetite for withdrawing quantitative easing by announcing a tapering of the €1.35tn pandemic emergency purchase programme, started in March, now roughly half expended
  • opposed ECB imitation of the Federal Reserve’s new policy of allowing consumer prices to rise beyond its targeted 2% to ‘make up’ for past undershooting, declaring that the ECB had sufficient independence to decide unpopular interest rate hikes should inflation revive
  • refused to countenance substantial relaxation of the ECB’s recommendation for euro area banks to desist from paying dividends – compensating, he said, for many banks’ receipt of state subsidies and a likely increase in loan impairments in the fourth quarter
  • stated the ECB’s readiness to launch a central bank retail digital currency as a primarily defensive measure in case of ‘an acceleration of demand or supply, or developments which would harm Europe’s sovereignty’
  • supported the ECB embracing anti-climate change measures in its 2020-21 strategy review. Asked whether the ECB intended to revisit the principle of market neutrality in the face of criticism of a carbon bias in its asset purchases, Mersch acknowledged that as public institutions, central banks cannot and should not resist societal changes. ‘The more we wait to adjust our instruments, the more we are perceived as not being part of what society aspires to.’ However, there was a big difference between ‘taking the political lead on change’ and ‘adjusting institutions’ areas of competence to such change’
  • voiced general confidence in the euro’s prospects as a currency built on ‘solidarity’, although he cautioned that difficult-to-implement European treaty change was needed to underpin Europe’s desire for more currency and economic ‘sovereignty’
  • rebuffed taking any blame for the ECB’s lack of action to restrain large-scale credit growth and ballooning money supply in peripheral euro members in the single currency’s early years, criticised by many – including Jacques Delors, former European Commission president – as helping cause the euro debt crisis
  • declined comments on the strengths in her job of Christine Lagarde, the ECB president, who since taking over from Mario Draghi in November 2019 has won general plaudits for her conciliatory style and political flair despite lack of classical central bank experience
  • singled out as turning points in the currency’s battle to build resilience Mario Draghi’s 2012 ‘whatever it takes’ speech shoring up the euro and post-2015 determination to prevent Greece from leaving the currency bloc. He underlined how Draghi’s London address was a surprise even to his speech-writers but succeeded ‘because he understands how markets work’
  • declared that the euro’s international use could rise because of the planned 2021 launch of major European Union borrowing to help finance the €750bn coronavirus crisis-fighting European recovery fund – although this would be a side-effect and not a goal of ECB policies
  • threw his weight behind revision of the euro area’s stability and growth pact – but said this was the responsibility not of the ECB but of governments and the European Commission.

Previewing the ECB’s 10 December meeting, Mersch emphasised that the bank will be ‘looking at existing instruments before looking at new tools’. In reviewing existing instruments, the central bank could consider several alternatives – extending their time horizon, expanding existing measures or their efficiency, or expanding their scope.

He noted that the ECB’s pandemic emergency asset purchases were ‘specifically geared towards meeting the consequences of this pandemic and is not to be mixed with our normal toolbox’. The programme’s flexibility addresses weaknesses in the transmission mechanism, especially through the flexibility on jurisdictions and on asset classes, as well as flexibility with regards to time.

Asked about cutting the deposit rate (the rate the ECB charges banks) against making targeted liquidity conditions even more favourable (the rate at which the ECB lends to banks), Mersch acknowledged that was at the heart of discussions on mitigating the ECB’s instruments’ negative secondary effects. This was relevant as negative interest rates edged closer to the so-called ‘reversal rate’ where the side-effects of expansionary policy outweighed the benefits. And while this remains unobservable, Mersch acknowledged ‘rapidly diminishing effectiveness’ before the reversal rate was actually reached.

Mersch said he recognised the limits of monetary policy and the need for fiscal action, stressing that ‘what monetary policy can do is give liquidity support…. That is what we are good at, and what our instruments are good for.’ He dismissed fears over fiscal dominance, voiced on 5 November in an OMFIF lecture by Jens Weidmann, Bundesbank president, stating they did not apply in the present setting where monetary policy is ‘rowing in the same direction as fiscal policy’.

David Marsh is Chairman and Danae Kyriakopoulou is Director of Research and Chief Economist of OMFIF.

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