Monday , September 21 2020
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The shadow of fiscal dominance: Misconceptions, perceptions and perspectives

Summary:
Isabel Schnabel of ECB in this speech defends ECB policies during the ongoing crisis in Europe since 2010: the euro area is still far from being a fiscal union. And even if it were, there would still be the question, as in other advanced economies, of whether rising debt has jeopardised, or will jeopardise, monetary dominance and, as a result, central bank independence. Indeed, some observers have taken the launch of the asset purchase programme (APP) and, more recently, the pandemic emergency purchase programme (PEPP) as a sign that the ECB has started monetising sovereign debt at the expense of its primary mandate of price stability. They accuse the ECB of undermining fiscal discipline by keeping interest rates artificially low and of assuming powers that the European Treaties

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Isabel Schnabel of ECB in this speech defends ECB policies during the ongoing crisis in Europe since 2010:

the euro area is still far from being a fiscal union. And even if it were, there would still be the question, as in other advanced economies, of whether rising debt has jeopardised, or will jeopardise, monetary dominance and, as a result, central bank independence.

Indeed, some observers have taken the launch of the asset purchase programme (APP) and, more recently, the pandemic emergency purchase programme (PEPP) as a sign that the ECB has started monetising sovereign debt at the expense of its primary mandate of price stability.

They accuse the ECB of undermining fiscal discipline by keeping interest rates artificially low and of assuming powers that the European Treaties reserve for national governments.

Deviations from the capital key under the PEPP are interpreted as tailoring monetary policy towards the most highly indebted euro area countries, in order to ease their debt burden and avoid destabilising the currency union as a whole.

These claims are not new. Central bank independence was already coming under close scrutiny before the pandemic, not only in the euro area.[3]

I would like to structure my remarks in three parts.

The first part deals with the misconception that the ECB’s policies constitute a form of “financial repression”.

The second part discusses the disciplinary function of sovereign bond markets and provides evidence that it has not been lost in the wake of the ECB’s unconventional policies. I will also argue that market failures imply a role for central banks in stabilising government bond market in times of stress.

The third and final part opens up perspectives on the changed interactions between fiscal and monetary policy in a low-interest-rate environment and what it implies for the longer term.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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