Weidmann Says ECB Stimulus Risks Hurting Market Discipline

The European Central Bank’s recent decision to boost its emergency bond-buying program risks weakening market discipline, Governing Council member Jens Weidmann said.

The Bundesbank president, who was a key holdout during policy makers’ recent stimulus deliberations, said that there was a clear need for the central bank to act in response to the weakening outlook brought about by the pandemic. However, it’s “crucial” that the amount of government bonds held by the ECB doesn’t become too large.

“Otherwise we run the risk of gaining dominant market influence and leveling out the differences in the risk premiums of government bonds. This further weakens market discipline,” he said in a virtual speech on Wednesday. “This problem has been exacerbated in particular by the recent increase in the Pandemic Emergency Purchase Program.”

Weidmann Says ECB Stimulus Risks Hurting Market Discipline

He added that “even -- and especially -- in times of crisis, three things are important in monetary policy: the right amount, the choice of the right instruments, and a smart design of the programs.”

ECB officials decided last Thursday to boost their emergency bond-buying program by 500 billion euros ($609 billion) and extend it until at least March 2022. The move won broad support only because hawkish officials secured a caveat specifying “the envelope need not be used in full,” people familiar with the discussions said at the time.

France’s central bank governor, Francois Villeroy de Galhau, said separately that the ECB is “far from a narrow control of spreads or sovereign rates.” But he welcomed the fact that the ECB has preserved favorable financing conditions in the crisis, particularly for Italy.

“Normally, crises widen the divergence between countries in the euro area. This time, thanks to the action of the central bank, situations have converged,” Villeroy said in an interview with French magazine Alternatives Economiques.

Fiscal Dominance

Weidmann argued in his speech that rising government-debt levels in general could put pressure on central banks to keep interest rates low in the future.

“If fiscal policy makers expect monetary policy to hurry to the rescue in the end, they could take public finances for granted and accumulate additional debt,” he said. “That could increase the pressure on the central bank later, and it would be all the more difficult to withstand this pressure.”

ECB Vice President Luis de Guindos, also speaking Wednesday, said fiscal policy continues to be the first line of defense in countering the economic impact of the coronavirus crisis. While governments are right to increase spending now, those with high debt levels “will have to pay attention to fiscal sustainability” once the pandemic is over, he added.

His ECB Executive Board colleague Isabel Schnabel stressed in a separate speech that funds from the European Union’s recovery package should be used “as productively as possible to sustainably increase countries’ growth potential, thereby mitigating the risk of economic divergence.”

©2020 Bloomberg L.P.

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