ECB ‘shouldn’t shirk from printing money’

EUROPEAN Central Bank executive board member Lorenzo Bini Smaghi says that policymakers shouldn’t shirk from using quantitative easing if deflation becomes a danger to the euro region.

“I do not understand the quasi-religious discussions about quantitative easing,” Bini Smaghi, who will leave his post at the end of the month, said in an interview published yesterday by the Financial Times. The ECB confirmed the comments.

“It is appropriate if economic conditions justify it, in particular in countries facing a liquidity trap that may lead to deflation.”

Unlike the US Federal Reserve and the Bank of England, the ECB has offset liquidity created by purchases of government bonds so that such operations don’t amount to quantitative easing that stokes inflation.

ECB executive board member Juergen Stark told Germany’s Die Welt newspaper that the central bank doesn’t “have a mandate” for unlimited purchases of government bonds.

Stark, who resigned in September to protest bond purchases, said while the euro-region economy could shrink at the end of 2011, deflation threats are “significantly lower” than after the collapse of Lehman Brothers in 2008.

“Central banks are given a clear mandate, to achieve price stability, and the independence to achieve it through the instruments they consider most appropriate,” Bini Smaghi said.

“If conditions changed and the need to further increase liquidity emerged, I would see no reason why such an instrument, tailor made for the specific characteristics of the euro area, should not be used.”

The ECB this month cut its benchmark interest rate to 1% and has never followed the Fed or Bank of England in trimming the cost of borrowing below that level.

Quantitative easing “is implemented in the UK and US, where the central banks consider that there are risks of deflation and where the policy rate is constrained by the zero lower bound”, Bini Smaghi said.

“This is currently not the case in the euro area because the ECB currently sees no risk of deflation.”

Instead of more bond purchases, the ECB has so far opted to grease the banking system with unlimited liquidity of up to three years, hoping financial institutions will lend the money on to companies and households. The institution loaned banks a record €489 billion for three years on Wednesday to avert a credit crunch.

“The interest in the long-term refinancing operation may be a sign of confidence gradually returning,” Bini Smaghi said.

“If this is right, interest rate spreads would be pushed down and create profitable opportunities. It would generate a herd movement in a positive direction.”

Risks of a eurozone break-up are “low” if “policy makers and citizens in the euro area are rational”, he said.

He said he is “not sure” if issuing common euro bonds would be the most effective solution to solve the crisis. “I could nevertheless envisage a limited amount of joint and several issuance to finance, for instance, specific projects, pan-European infrastructure or a common bank restructuring fund.”

Asked whether the EU should continue integration without Britain, Bini Smaghi said that “continental Europe needs the UK”.

He also criticised rating companies for threatening to downgrade countries that “over the past few months have undertaken the toughest fiscal adjustment program, and thus improved their fundamentals”, while “those that have postponed adjustment, gaining time in particular through easy financing by the central bank, have been considered to be in better shape”.

Bloomberg