The European Central Bank could deploy exceptional monetary measures even if interest rates fell to zero, a senior policymaker has argued, indicating that the ECB feels it still has plenty of ammunition to fight the economic downturn.
Athanasios Orphanides, central bank governor of Cyprus, argued that “the idea that monetary policy becomes ineffective and cannot provide expansionary impetus when the short term interest rate is very low, or zero, is a fallacy.”
His comments suggested that the ECB could follow the US Federal Reserve in actively considering unorthodox ways of boosting the economy – for instance by buying government or corporate bonds. So far, Jean-Claude Trichet, ECB president, has not gone beyond saying that such steps would be “possible”.
Although Mr Orphanides represents one of the smallest of the eurozone’s 15 member states, his voice carries extra weight because of his experience as an economist and adviser at the US Fed.
However, Mr Ophanides’s speech in Larnaka, Cyprus, on Thursday, highlighted a clash of views within the ECB’s 21-strong governing council. The ECB slashed its main policy interest rate by 75 basis points last week to 2.5 per cent – its largest ever reduction. But other council members have hinted strongly that they do not want to see official borrowing costs falling much farther.
Jürgen Stark, an ECB executive board member, warned earlier this week that “the remaining room for manoeuvre is very limited, potentially allowing for small steps only”. He appeared to rule out any movement in January by arguing additional information that would allow a re-assessment of inflation risks was unlikely to be available by February or March.
Separately, Axel Weber, Bundesbank president, said in a German newspaper interview on Friday that he would prefer to avoid lowering the policy interest rate below 2 per cent.
Mr Ophanides emphasised that further ECB actions would be based on a careful assessment of macroeconomic developments. But he argued that “a money-issuing central bank does not have limitations in increasing the quantity of money by expanding its balance sheet”.
He added: “By doing so it can have a positive effect on nominal asset prices and influence longer term interest rates even if the overnight rate is unaffected. To be sure, monetary policy is more challenging in such circumstances, and the stance of monetary policy is harder to infer from short-term interest rates, but these challenges do not limit the effectiveness of monetary policy.”