BERLIN (MNI) – ECB Executive Board member Lorenzo Bini Smaghi on
Friday praised the independence of the central bank, stressing this
assures that fiscal problems will not be resolved via higher inflation.

“The role of the central bank should remain distinct from that of
the fiscal authorities, and monetary policy should remain firmly in the
hands of the central bank,” Bini Smaghi said in remarks for a conference
of the Peterson Institute in Washington.

“It is the best way to ensure that budgetary problems are addressed
in a democratic way, rather than through the manipulation of the
currency, which has hidden distribution effects on the population,” the
Executive Board member reasoned.

“In Greece, Ireland and Spain, in France and Germany, the
governments are adopting budgetary policies in full awareness of the
fact that they cannot count on the inflation tax to solve their fiscal
challenges, challenges that all advanced societies have to face,” he
stressed.

After a financial and housing bubble has burst, growth potential is
impaired and possibly even reduced for some time, Bini Smaghi remarked.
“According to all major international institutions, this also applies to
the current period,” he noted.

“Monetary policy can smoothen the transition to the new steady
state, but it cannot by itself pull the economy back to the pre-crisis
level, which was not in a sustainable equilibrium, within a short period
of time,” he said.

“The recapitalisation and restructuring of the banking system is
far more important than monetary policy in avoiding a credit crunch.”

Commenting on currency matters, the central banker pointed out that
many important emerging market economies either do not have any monetary
policy at all, because they have pegged their exchange rate to the
currency of an advanced economy, or impose capital controls and restrict
the international use of their own currency.

“Rather than talking about ‘monetary wars’, which makes little
sense, more attention should be devoted to what I would call a ‘monetary
void’ in the world economy,” the Executive Board member said.

“As a result of such a void, many of the problems experienced by
advanced economies before the crisis, like very low levels of interest
rates – especially in comparison with the underlying rate of economic
growth – are now migrating to emerging markets, with potentially very
critical consequences for both these economies and the global system,”
he warned.

More attention needs to be paid to these issues, and to their
consequences with respect to achieving a balanced and sustained recovery
of the global economy, Bini Smaghi said.

The past crisis has shown that the growth recorded in advanced
economies that experienced large current account deficits over the last
decade was not sustainable, he observed.

“For macroeconomic policies to continue to be aimed at the
attainment of similar rates of growth in the future would imply
generating the same imbalances that led to the crisis,” the central
banker asserted.

The view that monetary policy should not look at financial market
conditions and should only intervene to counter the effects of the
bursting of the bubble has been proven wrong in the crisis, he said.

Another lesson from the crisis is that “interest rates were kept
too low for too long before the crisis, mainly on account of fears that
the economy would enter a Japanese-style deflation, fears that turned
out to have been mistaken,” the Executive Board member said. Risk
management-type monetary policy aimed at avoiding deflation is thus not
without risk, he noted.

Moreover, “core inflation is not a good predictor of headline
inflation, nor of underlying inflationary pressures emerging in a global
economy,” the central banker stressed.

He also noted that it is very difficult to measure output gaps.
“Therefore, it is very dangerous to calibrate monetary policy mainly on
the basis of this variable.”

–Berlin bureau: +49-30-22 62 05 80; email: twidder@marketnews.com

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