Praet Says Monetary Policy Can’t Address Cause of Crisis

European Central Bank Executive Board member Peter Praet said monetary policy can’t address the root causes of the current crisis and that abundant liquidity can create unwanted side effects.

It should be kept in mind that “monetary policy can exert mitigating effects, but cannot solve the underlying problems, often of a structural nature,” Praet said at a speech in Milan today. “In addition, the creation of abundant liquidity can in itself create side effects that need to be carefully monitored.”

The sovereign debt crisis, which erupted in Greece about three years ago, has forced five of 17 euro-area countries into seeking bailouts and eroded investor confidence in the monetary union. ECB President Mario Draghi in August unveiled a plan to buy government bonds to quash speculation of a euro breakup. The German Bundesbank opposes the plan, saying it is tantamount to financing governments.

The program, dubbed Outright Monetary Transactions, addresses “severe distortions in government bond markets which in particular originate in unfounded fears on the part of investors of the reversibility of the euro,” Praet said. It also aims “to safeguard the monetary policy transmission mechanism in all countries of the euro area, thereby preserving the singleness of the ECB’s monetary policy.”

Long-Term Loans

Referring to the ECB’s long-term refinancing operations, Praet said “there are indications” that they “have proven effective in preventing an abrupt deleveraging” in the financial sector.

The ECB pumped more than a trillion euros ($1.3 trillion) into the region’s banks via two three-year LTROs over the past year in an effort to unfreeze interbank lending and restart economic growth. “They significantly helped in restoring confidence in financial markets,” Praet said.

Turning to plans for a common euro-area banking supervisor run by the ECB, Praet said it should establish “a common resolution framework, including a resolution authority at euro- area level.”

To contact the reporters on this story: Stefan Riecher in Frankfurt at sriecher@bloomberg.net; Chiara Remondini in Milan at cremondini@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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