Excessive government spending hampers ECB activity, says Knot By Reuters

ROTTERDAM (Reuters) – Excessive government spending has made it harder for the European Central Bank to bring down inflation and tighter government discipline is needed for new budget rules to work, ECB policymakers Klaas Knot said on Tuesday.

The ECB raised interest rates at a record pace in 2022 and 2023 to combat inflation. The policy reversal, which began with an interest rate cut in June, is expected to be slow as price pressures continue to persist and inflation will remain above the ECB’s 2% target until the end of next year.

“We see that an inadequate fiscal stance can hinder the effectiveness of monetary policy,” said Knot, the head of the Dutch central bank. “In this case, a more restrictive fiscal policy would have been desirable.”

While new fiscal rules were introduced in May, Knot said they did not mean an automatic improvement in the relationship between the ECB and the finance ministries of the 20 countries that share the euro.

The new rules give governments more flexibility to spend more in times of recession, but they will only work if national governments reduce their debt during the crisis.

“Whether that happens will largely depend on compliance and enforcement,” Knot said. “In this sense, the new EU tax framework will immediately have to prove itself.”

It would be helpful if the bloc had some sort of central budget capacity as during the pandemic, but overall spending should not increase, so any supranational spending must be accompanied by reduced spending in national budgets, Knot argued.

EU nations have joined forces during the pandemic to finance the Next Generation EU recovery fund, but some countries, notably Germany, insist it should be unique and there should be no permanent joint loan.

The ECB has long argued that balancing a single monetary policy with 20 different fiscal policies is nearly impossible, and that some form of common budget would make policy more effective and less costly for growth in periods of hyperinflation.