FRANKFURT (MNI) – It is important for the European Central Bank to
return to “normal” monetary policy, though the challenging part is to
know when, ECB Governing Council member Klaas Knot said in an interview
with the magazine published Monday by the Dutch National Bank, which he
heads.

Knot acknowledged that lending to banks at a fixed rate and with
full allotment was necessary to keep the interbank money market afloat
in a time of crisis.

“But you can’t keep pumping unlimited money into the financial
system,” Knot said. “It will inevitably lead to high inflation and
rising prices.”

However, the central banker recognized that there were risks in
unwinding the ECB’s liquidity policy, because the timing has to be
right.

“If you’re too early, the financial system is stuck again,” he
explained. If you are too late, “you get high inflation.”

The ECB has wrestled with this question for much of the past three
years, at times being prepared to wind down its emergency liquidity
operations only to forced to put those plans on hold when the crisis
flared up again.

The ECB had ended six-month refinancing operations only to bring
them back again — on two occasions. It last offered a one-year LTRO at
full allotment in December 2009, but numerous ECB Governing Council
members have signaled in recent days that the bank might re-introduce
that long-term refinancing operation at its next meeting on October 6.

Turning to Greece, Knot stressed that the country was not in a
“hopeless” situation and that, with privatization, it could reduce its
debt to “manageable” levels.

He also noted that the deterioration in market confidence was
turning into a sort of self-fulfilling prophecy, using the case of Italy
as an example.

However, the situation in the periphery is not all due to volatile
markets, Knot continued.

“You could well say that Italy – as well as Spain, Ireland and
Greece – did not take advantage of the good economic years to put their
finances in order,” he said, adding that these countries were therefore
to blame.

Knot called on the countries in the periphery to bring their
finances under control and stressed that, while the process would take
time, it was “the only structural solution available.”

“This means effective tax levies, less spending and market reform,”
he said.

Asked about Eurobonds, Knot stressed that this should be used as a
last resort, reiterating his point that fiscal and economic reforms must
come first.

Knot was more dismissive of the idea of allowing a state to pay
back only a portion of its debt for a “simple reason: those who borrow
money also have the obligation to pay it back.”

On a more positive note, Knot called the euro a “stable and strong”
currency, adding that it was because of the euro that the Eurozone had
low inflation. “Citizens benefit from it daily,” he said, adding that
prices are more stable in Germany than during the Bundesbank era “in its
best years.”

Knot’s interview was published in Dutch and his comments were
translated to English by Market News International.

— Frankfurt bureau: +49 69 720 142; email: frankfurt@marketnews.com —

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