European Central Bank council member Jens Weidmann said calls for the central bank to do more to fight the sovereign debt crisis overestimate its capacity.
“Monetary policy is not a panacea and central bank firepower is not unlimited, especially not in a monetary union,” Weidmann said in a speech in New York today. “We can only win back confidence if we bring down excessive deficits and boost competitiveness. And it is precisely because these things are unpopular that makes it so tempting for politicians to rely instead on monetary accommodation.”
ECB policy makers have brushed off demands from the International Monetary Fund and the U.S. for more action to stem the debt crisis, as markets push Spain’s borrowing costs toward levels that prompted Greece, Ireland and Portugal to seek international bailouts. The Frankfurt-based ECB has already cut interest rates to a record low and pumped more than 1 trillion euros ($1.3 trillion) into the euro area’s banking system in a bid to avert a credit crunch.
Spain’s 10-year bond yields rose to almost 6 percent today as the government struggles to convince investors it can shore up banks without overburdening public finances. Weidmann said delays in implementing announced deficit cuts and reforms risk damaging “confidence in policy makers’ ability to get to the root of the crisis.”
The Washington-based IMF last week lobbied the ECB to consider lowering its benchmark interest rate and keep its crisis-fighting measures in place, presaging comments from U.S. Treasury Secretary Timothy F. Geithner, who said the central bank needed to act more decisively and flexibly to contain the turmoil.
“More of the same will not take us anywhere,” Weidmann said. “The analgesic we administer comes with side effects. And the longer we apply it, the greater these side effects will be, and they will come back to haunt us in the future.”
The ECB will need to act if inflation pressures increase, he said.
“Taking into account rising energy prices and robust core inflation, prices could rise faster than the IMF expects,” Weidmann said. “Even if we are concerned about the impact on the peripheral countries, monetary policy makers must do what is necessary once upside risks for euro-area inflation increase.”
Weidmann said he doesn’t want to “deny the necessity of containing the crisis. But all that can be gained is the time to address the root problems.”
The ECB today said it refrained from making any government bond purchases for a sixth straight week, even as Spanish officials call on it to intervene. While markets may now be “overshooting” in the case of Spain, Weidmann said, higher borrowing costs could spur reforms.
“We should not forget that market interest rates are an important signal for governments regarding the state of their finances and that they are an important incentive for reforms.”
Answering a question on whether the ECB’s bond purchases should be linked to countries implementing reforms, Weidmann said he believes “they shouldn’t be linked at all.
“It’s not our job to reward or sanction policy makers for their actions,” he said. “Our job is to do monetary policy. And if those purchases are needed to implement our monetary policy, we should do them.”
Weidmann said there needs to be more clarity about the direction that Europe’s monetary union is taking.
“We have to reduce public debt and we have to further improve the institutional framework of monetary union,” he said. “We therefore have to think about the future now -- and we have to act accordingly as well.”
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