European Central Bank Executive Board member Lorenzo Bini Smaghi said that policy makers shouldn’t shirk from using quantitative easing if deflation becomes a danger to the euro region.
“I do not understand the quasi-religious discussions about quantitative easing,” Bini Smaghi, who will leave his post at the end of the month, said in an interview published yesterday by the Financial Times. The ECB confirmed the comments. “It is appropriate if economic conditions justify it, in particular in countries facing a liquidity trap that may lead to deflation.”
Unlike the U.S. Federal Reserve and the Bank of England, the ECB has offset liquidity created by purchases of government bonds so that such operations don’t amount to quantitative easing that stokes inflation. ECB Executive Board member Juergen Stark told Germany’s Die Welt newspaper in an interview published today that the central bank doesn’t “have a mandate” for unlimited purchases of government bonds.
Growth prospects in Europe “have deteriorated” since September, U.K. central bank Governor Mervyn King said yesterday after a risk assessment by European officials. Stark, who resigned in September to protest bond purchases, said while the euro-region economy could shrink at the end of 2011, deflation threats are “significantly lower” than after the collapse of Lehman Brothers Holdings Inc. in 2008.
The euro traded at $1.3080 at 8:59 a.m. in Frankfurt, up 0.2 percent on the day. The single currency has depreciated 3.1 percent against the dollar over the past three months as European leaders struggled to contain the region’s debt crisis.
“Central banks are given a clear mandate, to achieve price stability, and the independence to achieve it through the instruments they consider most appropriate,” Bini Smaghi said. “If conditions changed and the need to further increase liquidity emerged, I would see no reason why such an instrument, tailor made for the specific characteristics of the euro area, should not be used.”
The ECB this month cut its benchmark interest rate to 1 percent, and has never followed the Fed or Bank of England in trimming the cost of borrowing below that level. The Frankfurt- based institution has opposed demands to step up government bond purchases to cap borrowing costs in Europe’s peripheral nations.
Quantitative easing “is implemented in the U.K. and U.S., where the central banks consider that there are risks of deflation and where the policy rate is constrained by the zero lower bound,” Bini Smaghi said. “This is currently not the case in the euro area because the ECB currently sees no risk of deflation.”
Instead of more bond purchases, the ECB has so far opted to grease the banking system with unlimited liquidity of up to three years, hoping financial institutions will lend the money on to companies and households. The institution loaned banks a record 489 billion euros ($636 billion) for three years on Dec. 21 to avert a credit crunch from the sovereign debt crisis.
“The interest in the long-term refinancing operation may be a sign of confidence gradually returning,” Bini Smaghi said. “If this is right, interest rate spreads would be pushed down and create profitable opportunities. It would generate a herd movement in a positive direction.”
Bini Smaghi will take up a position at Harvard University’s Center for International Affairs on Jan. 1. He will also become chairman of Italian utility Snam Trasporto on the same date, the company said yesterday.
Bini Smaghi dismissed calls for the ECB to act as a lender of last resort to distressed governments. “Central banks act as lender of last resort to the financial system,” he said. “The concept of lender of last resort to governments is misplaced.”
Risks of a euro area breakup are “low” if “policy makers and citizens in the euro area are rational,” Bini Smaghi said.
The policy maker said he’s “not sure” if issuing common euro bonds would be the most effective solution to solve the crisis. “I could nevertheless envisage a limited amount of joint and several issuance to finance, for instance, specific projects, pan-European infrastructure or a common bank restructuring fund.”
Asked whether the Europe Union should continue integration without Britain, Bini Smaghi said that “continental Europe needs the U.K., where the largest financial center is located and where there is the greatest financial market expertise.”
“The U.K. financial system needs access to the continent where most of its clients are,” he said. “There can be no prosperity for either based on beggar-thy-neighbor policies.”
He added that it’s in the interest of the City of London “that the euro succeeds.”
Bini Smaghi criticized rating companies for threatening to downgrade countries that “over the past few months have undertaken the toughest fiscal adjustment program, and thus improved their fundamentals,” while “those that have postponed adjustment, gaining time in particular through easy financing by the central bank, have been considered to be in better shape.”
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