ECB Told Home Prices, Fiscal Spending Key as Strategy Reviewed

The European Central Bank should target higher average inflation -- unless house prices are soaring -- and governments must spend their way out of recession, according to economists attending the institution’s annual forum.

ECB President Christine Lagarde will open this year’s event on Wednesday, with Federal Reserve Governor Jerome Powell and Bank of England Governor Andrew Bailey joining her over two days. Normally held at a luxury hillside resort in Sintra, Portugal, this time it’s online because of the pandemic.

The discussions come as central bankers boost monetary stimulus to unprecedented levels to help counter the latest hit from lockdowns. The BOE acted last week and the ECB is expected to do so again before the end of the year.

Officials are also grappling with longer-term economic challenges though, such as globalization, climate change and digitalization. The forum, which will feed into the ECB’s strategy review, is intended to air those issues.

Falling Interest Rates

Klaus Adam from the University of Mannheim delves into a fundamental trend worrying central banks -- the slump in the so-called natural rate of interest.

That’s the interest rate consistent with stable inflation, and while it can’t be directly measured, the consensus is that it’s been on a relentless decline in advanced economies for decades. That’s forced institutions like the ECB into unconventional and aggressive policies such as negative policy rates and massive bond purchases.

ECB Told Home Prices, Fiscal Spending Key as Strategy Reviewed

Adam’s research backs the idea that the outcome probably increases market instability because of soaring asset prices.

His solution: policy makers should promise a somewhat higher average inflation rate. That’s a core issue in the ECB’s review, and echoes the shift by the Federal Reserve this year.

Adam says central bankers should also pay closer attention to house prices, which correlate closely with investment. He argues that officials should keep policy tighter when real-estate prices rise -- undershooting their goal for consumer-price growth -- and stay looser when they fall.

Sensible Spending

The ECB has long called on governments to help it to lift the economy out of its long-term malaise, and Evi Pappa from Universidad Carlos III de Madrid provides some evidence why politicians should listen.

She shows that additional fiscal spending is particularly potent in helping lift the economy out of a recession when rates are pinned near zero -- as long as such a splurge is accompanied by a careful assessment of debt sustainability.

Pappa is upbeat about the European Union’s 750 billion-euro ($890 billion) joint pandemic stimulus, singling out funds aimed at fostering investment in innovation and research as particularly effective.

Her paper also addresses an issue governments have so far tiptoed around. With what looks like a joint euro-area fiscal capacity taking shape, she argues, member states should also have the ability to restructure their public debts -- as a last resort and in an orderly way.

Go-Slow Globalization

Pol Antras of Harvard University addresses what he calls the “unsustainable increase” in globalization. While that means the process will slow, economies will remain intertwined, he says.

Companies may bring some production closer to home, but they are unlikely to suddenly pull back after investing heavily in international supply chains.

ECB Told Home Prices, Fiscal Spending Key as Strategy Reviewed

He notes a major risk though if the pandemic isn’t brought under control relatively quickly. Business travel -- a key feature of a globalized world -- could be disrupted for years.

Antras also reckons the crisis will almost certainly widen income inequality worldwide “due to the differential ability of skilled and unskilled individuals to work from home, and this again doesn’t bode well for the future of globalization.”

He recommends better tax systems to provide safety nets for those who lose their jobs or income because production moved elsewhere, so as to quench populism.

Carbon Bank

Lagarde is trying to make the ECB engage more explicitly with action over climate change, and Frederick van der Ploeg from Oxford University examines some of the rationale for that.

He argues that a disorderly transition to a carbon-free economy can lead to abrupt changes in market valuations and increase the risk of stranded assets. Such havoc in financial markets would hit pension funds and investment firms particularly hard -- some of them have nearly half of their equity portfolios exposed to carbon risk.

Ploeg suggests a more active and forceful role for central banks in weaning economies off fossil fuels. Climate policy should be a core interest of financial regulators and constitutes a fiduciary responsibility.

He argues that central banks should stimulate green investments by designing quantitative-easing programs that favor more climate-friendly assets, or at least avoid biases toward an “over-representation of carbon-intensive sectors, since this amounts to implicit subsidies for those sectors.”

He also has a radical proposal.

“If climate policy is too easily frustrated by lobbies, one should think of setting up an independent carbon central bank,” he write, with a mandate to “make sure that temperature and cumulative emissions stay below their ceilings.”

©2020 Bloomberg L.P.

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