Given the massive increase in government debt in the euro area, Bundesbank President Jens Weidmann has warned of the risk of fiscal dominance. He sees a risk that political pressure could arise and grow to keep interest rates lower than the rationale of price stability would call for, with cheap money increasingly being seen as the normal state. Under these conditions, even high debt burdens could appear sustainable to governments. “But what if conditions change?”, the Bundesbank president asked. He responded by saying that central banks already needed to make clear now that they are not going to place monetary policy at the service of fiscal policy, adding that “If we create a different impression, we are putting both our independence and our credibility at risk.” 

Expansionary monetary policy necessary in the crisis

Mr Weidmann regarded accommodative monetary policy as still being necessary during the coronavirus crisis. “It is important that monetary policy remains expansionary,” Mr Weidmann noted, “as the economic slump is weighing on the inflation outlook and a lack of liquidity in the financial system might dangerously aggravate the crisis. Adverse feedback loops between the economy and the financial system could also pose a risk to price stability.”

He added that the forceful resurgence of the pandemic will place a strain on the economy in the current quarter. “This time, the economic fallout is likely to be less severe than in spring, since the containment measures are more targeted and firms have gained experience.” Mr Weidmann pointed out, however, that it could take a while until COVID-19 is contained in a sustained manner. He added that from today's point of view it was not possible to rule out a succession of lockdowns and subsequent resurgences of the pandemic.

Formulate monetary policy aim understandably and realistically

Looking towards the Eurosystem's monetary policy strategy review, Mr Weidmann said that discussions should centre around the definition of price stability and the wording of the Governing Council’s policy aim. “Overall, I believe we should word our monetary policy aim so that it is understandable, realistic and forward-looking,” as he put it. He sees an explicitly symmetric formulation of the target as being clearer and easier to understand than the current wording. Mr Weidmann also stressed the importance of flexibility for monetary policy, adding “Let's be realistic: monetary policy cannot control inflation right down to the decimal point, let alone in a certain month or quarter.” Moreover, he noted, the Governing Council needed to examine whether inflation is being measured correctly. Mr Weidmann came out in favour of including owner-occupied housing in the basket of goods used to calculate the rate of inflation in the euro area. “Personally, I would be willing to accept some methodological shortcomings in order to better reflect people’s real-life situations,” he said.