–Says Price Stability Not Enough To Ensure Financial Stability

FRANKFURT (MNI) – Euro area consumer inflation is close to where
the European Central Bank wants it, but the core index is still soft,
ECB Governing Council member Anathasios Orphanides said here Thursday.

After describing the runup in energy prices in 2007 and early 2008
that brought Eurozone inflation to 4% at one point — more than twice
the ECB’s target — Orphanides noted that the financial crisis and
concomitant threat of deflation had pushed consumer prices the other
way, and that they had then bounced back once the financial crisis was
stabilized and the recovery started.

“Inflation is now back in positive territory and closer to the
ECB’s definition of price stability, but core inflation remains on the
low side,” Orphanides said at a conference sponsored by the Bank of
France.

Orphanides, who heads the Central Bank of Cyprus, observed that the
financial crisis has confirmed the need for central banks to focus on
price stability but has also shown that price stability is not enough to
ensure financial stability.

He said that interest rate changes were not the best policy for
dealing with financial instability, nor for addressing potential asset
bubbles developing over the long term. Central banks need new tools, he
argued.

“Perhaps the most significant challenge ahead of us is how to
improve the architecture of financial supervision and provide central
banks with the appropriate tools so as to better contribute to
maintaining financial stability,” Orphanides said.

He added: “In general, a central bank does not face a trade off
between price stability and financial stability but there may be
occasions when interest rate policy directed at preserving price
stability is clearly insufficient to reduce risks to financial
stability, such as persistently high credit growth in an environment of
price stability. Adjusting the interest rate tool is unlikely to be the
most appropriate response.”

Orphanides noted that the crisis had revealed a number of
weaknesses, including the lack of coordination in regulation and
supervision, the underappreciation of risk and crisis management.

However, while steps have been taken to address the first two
areas, the third element still needs to be properly addressed.

“Not much progress has been made towards a comprehensive European
crisis framework focusing on early intervention by supervisors, bank
resolution and insolvency proceedings,” Orphanides said.

He expressed no concern about the ECB’s two bond buying programs —
covered bonds and sovereigns — saying that both types of securities
were of “top quality.”

Orphanides also noted that the different crisis responses in the
U.S. and Europe were a function of differing institutions and economies.
Because the lion’s share of financing in Europe is via banks, the ECB’s
non-conventional measures necessarily target the banking sector, he
said. In the U.S., financing is much more via financial markets, which
is why the Federal Reserve “had to step in so forcefully” to buy market
securities.

He said that in the end, despite the differences, the Fed and the
ECB “achieved a very similar effect at the end of the day,” noting that
6-month dollar and euro market rates “have behaved quite similarly.”

–Frankfurt newsroom +49 69 720 142; e-mail: frankfurt@marketnews.com —

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