ADVERTISEMENT

ECB Toolbox Needs Flexibility for Times of Stress, Villeroy Says

ECB Toolbox Needs Flexibility for Times of Stress, Villeroy Says

Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

The European Central Bank should keep the flexibility of its crisis-fighting quantitative easing program by creating a “contingent option” that needn’t be part of its pre-existing bond-purchase tool, Bank of France Governor Francois Villeroy de Galhau said. 

Such a measure would be available to policy makers to activate if needed and give them more freedom than before the crisis to buy debt securities of different countries at times of market stress, he told Bloomberg News in written responses to questions. 

“Flexibility across asset classes and among jurisdictions has been key” in the Pandemic Emergency Purchase Program, he said. “It could be worth examining if and how these two elements should be kept in our ‘virtual toolbox.’ There can be various means to keep this virtual flexibility as a contingent option, and we should study them until December.”

The governor’s comments elaborate on speech remarks earlier this week where he called for the ECB to preserve the flexibility of PEPP. The central bank is studying new programs to avoid turmoil when that crisis program ends in March. Policy makers are gearing up for a showdown in December where the question of flexibility will be a point of contention. 

Read the full Villeroy transcript here

A decision to preserve PEPP attributes would mark a significant shift for the ECB, whose quantitative easing before the pandemic was constrained by self-imposed rules strictly limiting the quantity of bonds it could buy every month from different countries to ensure adherence to a treaty clause prohibiting government financing.

The euro traded little changed on Friday at just under $1.16, erasing earlier gains. European bonds fell with German 10-year yields up three basis points at -0.16%.

Villeroy said it may again be necessary in future to address “unwarranted stressed conditions” that would hamper the central bank’s core price stability mission.  The crisis has shown the ECB can do this responsibly, he said, and may actually have to intervene less than it would without new powers.

“We have proved with PEPP our capacity to address such very specific circumstances with seriousness, without creating moral hazard,” Villeroy said. “By the way, the mere existence of this potential and contingent flexibility would have a self-stabilizing effect.” 

ECB Toolbox Needs Flexibility for Times of Stress, Villeroy Says

The new “contingent option” would not necessarily be part of the ECB’s longstanding QE tool, the Asset Purchase Program, which Villeroy said “has its own logic and legal consistency.” He proposed the APP should be made more flexible only in terms of the timing of purchases.

The ECB is studying a new bond-buying program to prevent any market turmoil when emergency purchases get phased out next year, officials familiar with the matter told Bloomberg last week. 

‘Shortflation’

In the comments after meetings with counterparts around the world in Washington, Villeroy also dismissed investor concerns that slower growth and a surge in inflation could herald a period of “stagflation.” The global expansion is still strong and robust, he said, and price increases are mainly due to buoyant demand.

“Shortflation could be a better word to describe the current situation, since price pressures are the results of shortages, and should be mostly transitory,” Villeroy said. 

Further into the future, he said there is greater risk of inflation falling short than of exceeding the ECB’s target.

“The bottom line is that we need to be patient while remaining vigilant, in order to anchor euro area inflation around 2% in the medium term,” Villeroy said.

©2021 Bloomberg L.P.