European Central Bank may need to do more to boost economy

ECB worries that due to crisis people are adapting spending and prolonging weak growth

Peter Praet of ECB: noting that euro zone inflation could be even lower in 2015 than the 0.7 per cent forecast, he said, “this is why we have to be very vigilant and ask ourselves: Have we done enough?” Photograph: Jerome Favre/Bloomberg

Peter Praet of ECB: noting that euro zone inflation could be even lower in 2015 than the 0.7 per cent forecast, he said, “this is why we have to be very vigilant and ask ourselves: Have we done enough?” Photograph: Jerome Favre/Bloomberg

 

A top official of the European Central Bank says measures taken to stimulate the euro zone economy might not be adequate and the central bank may need to do more.

The comments by Peter Praet, a member of the central bank’s executive board, strengthened expectations that the ECB is moving closer to broad-based government bond purchases as a way of pumping money into the economy.

Added impetus, Mr Praet said, could come from the additional drag on consumer prices as a result of the recent drop in crude oil prices.

While he said that “the risk of broadly based deflation in the euro area is not high”, he noted that oil’s slump “could mean negative inflation during a substantial part of 2015”.

In an interview with Börsen Zeitung, a German financial newspaper, Mr Praet said the steps taken so far might not be enough to raise inflation from a level considered dangerously low because it undercuts corporate profits and makes it more difficult for borrowers to repay their debts.

“There is the risk that we won’t have achieved the degree of monetary accommodation that we had intended,” Mr Praet said, according to a translation of the interview on the ECB website.

Noting that euro zone inflation could be even lower in 2015 than the 0.7 per cent forecast by ECB economists, he added, “this is why we have to be very vigilant and ask ourselves: Have we done enough?”

The statement by Mr Praet, along with recent signals from other high-ranking ECB officials, suggest that action is increasingly likely at the next monetary policy meeting, on January 22nd.

But the central bank could delay an asset purchase programme to bring dissenting members of the policymaking governing council on board, or simply to allow more time to make preparations for what would be a huge and complex intervention in bond markets.

Political turmoil in Greece could delay asset purchases, because the ECB might be reluctant to acquire debt that a new Greek government might not repay.

Mr Praet said there was a danger that businesses and consumers were becoming resigned to low growth and low inflation and so were not investing and spending. If so, that would be one of the symptoms of deflation – a broad-based decline in prices that causes people to delay purchases, company profits to sink and unemployment to rise.

European Central Bank policymakers are increasingly worried about “the very high risk that after seven years of crisis and very poor economic performance in the euro area, businesses and households are reducing their long-term growth expectations and adapting to weak growth and low inflation”, Mr Praet said.

“The big risk is that this growth pessimism perpetuates the current situation of weak growth and low inflation,” Mr Praet said.

Many economists as well as central bankers in other countries have expressed concern that the ECB has already waited too long to address very low inflation. Prices rose at an annual rate of 0.3 per cent in the euro zone during November, and some analysts expect inflation to have slowed further during December or even to have turned negative. An official estimate of December inflation will be released on January 7th.

An asset purchase programme in the euro zone would be more complicated than the quantitative easing used by the Federal Reserve to stimulate the US economy. The Fed bought large quantities of US Treasury securities, but the euro zone has no comparable asset. The ECB would have to buy bonds of individual euro zone countries.

Mr Praet said the ECB might buy government bonds in the secondary market in proportion to the size of each country’s outstanding debt. That approach could be controversial because it would tend to reward the most indebted countries, such as Greece and Italy.

Mr Praet acknowledged that the ECB risked rewarding bad behaviour, a practice known as moral hazard. “Moral hazard is an issue for monetary policy; I don’t deny that,” he said. “At the same time, it cannot be an excuse not to act if you come to the conclusion that this is needed, given your mandate.” – New York Times