European Central Bank Should Distinguish between Monetary Tools, Says Dutch Chief
The European Central Bank (ECB) should make a clearer distinction between its instruments used to guide inflation and those aimed at stabilizing financial markets, according to Dutch central bank chief Klaas Knot. Knot, who has been a member of the ECB’s Governing Council for the longest tenure, emphasized the importance of separating instruments that steer the stance from those that support transmission.
In a recent speech in Paris, Knot emphasized that the ECB should prioritize separating monetary stance from safeguarding monetary transmission, which may require implementing policies in opposite directions. The chief noted that the separation principle has been blurred due to the quick succession of crises over the past decade, from ultra-low inflation to the pandemic and the current inflation surge.
Discussions on the ECB’s instrument usage are heating up, particularly as the bank is gearing up for a strategy review next year. The ECB’s use of bond purchases, its go-to instrument for most of the last decade, will likely be a key topic for discussion. While bond purchases can quickly stabilize markets, the debt remains on the bank’s balance sheet for an extended period. This has raised concerns, particularly among economists, that the ECB’s large holding of debt could have unintended side effects.
Some economists argue that short and temporary bond purchases should remain in use, but extended buys should be used with caution given their long-term effects. The Transmission Protection Instrument, which was used to calm markets and allow for the ECB to raise interest rates, is seen as an example of how instruments could be separated. The chief stressed that the distinction is crucial to ensure effective policy-making and to prevent unwanted consequences.