• Klaas Knot says further expansion could cause legal concerns
  • QE boost brings higher risk of financial instability

The European Central Bank is approaching the limits of its monetary policy, and further expansion of its asset-purchase program could give rise to legal and financial stability concerns, Governing Council member Klaas Knot said.

“A further expansion of the buying program will lead to increased tensions with the prohibition of monetary financing,” said Knot, who is also the president of the Dutch central bank. He made the comments in the bank’s annual report, published in Amsterdam on Thursday. The ECB is constrained by European Union law from directly funding government expenditure.

ECB President Mario Draghi unveiled a barrage of measures this month designed to arrest the euro-area’s slide toward deflation. As well as cutting its deposit rate by 10 basis points, the Frankfurt-based institution increased monthly bond purchases to 80 billion euros ($90 billion) from 60 billion, and added corporate debt to the list of assets its can buy. It also announced fresh targeted loans that could see banks paid to take central-bank cash and lend it to the real economy.

Knot said at a press conference in Amsterdam on Thursday that the marginal benefit of taking more measures is diminishing. “Technically it’s always possible to to more, but you can question whether the added value weighs against the side effects, and I’ve my doubts about that.”

Quantitative easing also leads to “higher risks of undesirable side effects like bubbles, an unhealthy search for yield, a rolling over of problematic loans, increasing wealth inequality and an addiction to low interest rates,” Knot said.

Another potential consequence is that governments become less inclined to work on structural reforms and reduce debt, given the generosity of monetary policy, Knot said. “The ball is now clearly in the court of the politicians”, he added.

Knot argued that more time is needed to evaluate the impact of the monetary policy measures already taken.

“Given the depth of the shock that took us away from the 2 percent inflation goal, it’s not a strange idea that the time which is necessary to get back to that level will be longer than the 18 to 24 months we normally consider for our medium term inflation goal.”

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