European Central Bank Executive Board member Peter Praet said the longer the ECB maintains loose monetary policy, the less effective it may become.
“I am referring to what used to be known as ‘instrument instability’ in policy-making,” Praet said in a speech in Frankfurt today, according to a copy provided by the ECB. “The need to apply larger and larger doses of the same policy interventions only to see their macroeconomic influence becoming more and more tenuous.”
The ECB has cut its benchmark rate to a record low of 0.75 percent, extended over 1 trillion euros ($1.3 trillion) in cheap loans to banks and pledged to buy the bonds of debt-strapped nations if they agree to economic reforms. While ECB President Mario Draghi has said there’s no reason to think about exiting accommodative policy now, other ECB officials including Germany’s Jens Weidmann have warned about the risks inherent in extended periods of low rates and excess liquidity.
“Expectations that interest rates will remain low for a long time, and that abundant liquidity will be provided, might weaken the incentives for banks to downsize operations and repair their balance sheets,” Praet said, adding that the ECB has “all the necessary instruments” to reduce liquidity in the financial system.
While monetary policy can smooth the reform process in Europe, the “need for adjustment is there and you can’t escape it,” Praet said. “Structural reforms are the answer” and “if you have credible commitments on structural reforms, you can be a bit more relaxed about fiscal policy.”
The efforts of countries like Greece and Spain to rebalance their economies and regain competitiveness are beginning to show results, and “green shoots” of growth are becoming evident in the region, Praet said.
“We have also seen strengthening exports in a global environment that is not really buoyant,” he said. “This indicates that the countries’ efforts to rebalance their economies are starting to bear fruits.”
Praet added that progress can be seen in structural reforms to open the region’s economies, in the reduction of private indebtedness, and in the repair of governments’ balance sheets.
“All of these developments give reasons to be cautiously optimistic about the prospect for crisis-ridden countries’ return to a path of sustainable growth,” Praet said.