Copious budget spending in the euro zone is finally generating a sustainable rise in inflation but more flexible fiscal rules will be needed for years as monetary policy remains constrained, European Central Bank policymaker Klaas Knot said on Friday.
Governments have spent record amounts over the past year to save their economies from a pandemic-induced downturn but as the recovery takes hold, a debate is underway on how and when to bring back temporarily suspended budget rules.
“Now we are in a better position to see a sustainable increase in inflationary pressures,” Knot said in a university lecture. “It will take a while because there’s still a huge amount of slack in the labour market.”
He added this year’s rise in consumer prices is still seen as temporary but some upside risks are “slipping into” projections, partly because of efforts by governments to insulate their economies.
Instead of reverting to old budget rules that could once again overburden the ECB after the pandemic, Knot argued for an overhaul of the Stability and Growth Pact togive governments more flexibility to spend outside crises.
“As the current low interest rate environment is likely to persist, we need a structurally larger role for fiscal policy in macro-economic stabilization for the foreseeable future,” the head of the Dutch central bank said in a speech.
“Fiscal flexibility is needed and has to be an integral feature of the framework, rather than an all-or-nothing button which may, or may not, be pressed in an emergency,” Knot added.
New rules need to improve coordination of national fiscal policies within euro zone, much like the bloc is doing with the New Generation EU Fund, and must have flexibility beyond automatic stabilizers and emergency measures.
But they must not give governments a free rein to spend so “robust and credible” rules are also needed to keep debt sustainable and ensure that spending adds to productivity, so the expenditure would eventually pay for itself.
“We should not be left thinking that this huge stack of public debt that the European Central Bank currently has on its balance sheet will sit there forever,” he added.