Lane says loose central bank policy and big spending still needed

European Central Bank Chief Economist Philip Lane. Photo Aidan Crawley/Bloomberg

Donal O'Donovan Twitter Email

February 10 2021 02:00 AM

The combination of loose monetary policy and high public spending should to be maintained to lift the economy towards recovery, according to ECB chief economist Philip Lane. .

The former Central Bank of Ireland governor said that ensuring monetary and fiscal policy are both supportive needs to be the main focus for policy makers for the ‘next while’ rather than action to cut debt.

Large scale wealth transfers, such as income supports, and front loading public investment including in infrastructure where possible, are also appropriate policies, he said.

He was speaking at an online seminar organised by the Irish Fiscal Advisory Council (IFAC). Dr Lane refused to be drawn on a suggestion that the vast amount of government bonds now held by the ECB could be parked or sidelined in order to allow a return to more normal monetary policy including escaping the trap of negative interest rates.

Around a third of Irish government debt is held by the Central Bank. The interest paid by the State to the Bank is quickly returned to the Exchequer but the money handed over when the debt is repaid is destroyed – in order to take it out of circulation.

That creates an opportunity for a fix not available with the government debt held on the market, economist Charles Wyplosz of the International Centre for Monetary and Banking Studies in Geneva told the seminar.

The past decade’s combination of lose monetary policy and tight fiscal policy should be flipped in favor of looser government spending but tighter interest rate policy, he said. That would lift interest rates and hurting highly indebted governments but only if central banks that hold much of the debt insist on treating the bonds as normal asset, he said.

Dr Lane refused to be drawn on the scenario outlined, but did say that evidence from both the global financial crisis and the pandemic was that countries with capacity to add debt at the start of a crisis were better able to cope – indicating that large deficits will need to be reduced once the crisis passes in order to rebuild the ability to deal with a future shock.

That point was also made by Eddie Casey of the Fiscal Council itself, who presented research that showed countries with high government debt are significantly worse hit when an economic shock does happen and also slower to recover.

The past year has seen central bank monetary policy including negative interest rates and huge bond buying run alongside expansionist fiscal policy to offset the economic impact of the pandemic.