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Categorized | Currencies, Economy

ECB dismisses supply side view of eurozone woes


Posted on January 31, 2015

European Central Bank (ECB) President Mario Draghi and Vice President Vitor Constancio (L) leave after addressing an ECB news conference in Frankfurt January 22, 2015. The European Central Bank took the ultimate policy leap on Thursday, launching a government bond-buying programme which will pump hundreds of billions of new money into a sagging euro zone economy. The ECB said it would buy government bonds from this March until the end of September 2016 despite opposition from Germany's Bundesbank and concerns in Berlin that it could allow spendthrift countries to slacken economic reforms. Man at right is a security guard. REUTERS/Kai Pfaffenbach (GERMANY - Tags: BUSINESS)©Reuters

The ECB vice-president has launched a staunch defence of the central banks’s quantitative easing programme, saying large-scale asset purchases were necessary to counter Europe’s problem of insufficient demand.

Speaking at the Cambridge Union in Cambridge, Vitor Constâncio attacked what he called a ‘misguided view’ that the Eurozone economic problems were solely the result of supply side problems.’ He insisted that the Eurozone needed to ‘raise aggregate demand’ to escape the risk of a debt trap.

    Last week, the ECB launched a €1.1tn programme of quantitative easing, which included for the first time large-scale purchases of sovereign bonds from all Eurozone countries. The measures are aimed at preventing the risk that the currency union falls into a prolonged period of deflation.

    On Friday, Eurostat, the Eurozone statistical office, reported that inflation in the currency area stood at -0.6 per cent, significantly below the central bank’s target of just under 2 per cent.

    Mr Constâncio said the ECB was facing a ‘very risky situation’ involving the possible dis-anchoring of medium-term inflation expectations. The widely-followed indicator showing the average expected inflation rate over five years starting in five years as priced by swaps markets had fallen below 1.7 per cent in the weeks before the ECB launched its QE programme, but has edged up since.

    He added that the current economic problems of the Eurozone resulted from a ‘negative aggregate demand shock’ which was already causing social and political tensions in the currency area. This was different from the situation in 2011 and 2012, when the Eurozone had suffered from a financial shock. ‘The default risk is now the result of the risk of a prolonged depression,’ he said.

    The ECB vice-president acknowledged there was a risk that countries could slow down on efforts to reform their economies as a result of the central bank’s sovereign bond purchases. This argument is often made in Germany, where policy makers have been long opposed to QE. But he said ‘a central bank could not be reduced to inaction’ by arguments over the possibility of so-called moral hazard.

    He added that while asset purchases had the potential to trigger a dangerous search for yield by investors, the primary responsibility of the ECB was over the price of goods and services, not financial assets. This should be addressed via other instruments, such as macroprudential policies.

    With regard to the situation in Greece, Mr Constâncio said the ECB’s rules over the provision of liquidity to Eurozone banks were ‘public and there would be no surprises in that sense’. The ECB will continue to provide a waiver on collateral below investment grade in normal monetary policy operations provided Greece stayed in an adjustment programme.

    With regard to the risk that the ECB could cut emergency liquidity assistance to Greek banks, he said this was a decision for the governing council to take.