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ECB Must Act to Fend Off Deflation, Bank of Spain Official Says

The European Central Bank must introduce additional monetary policy stimulus in December to stave off the risk of deflation in the euro zone, the Bank of Spain’s chief economist said.

“We know that in order to ensure such a risk doesn’t materialize, we must act swiftly and forcefully,” Oscar Arce, the Spanish central bank’s director general of economics, said in an interview in Madrid on Tuesday. The prospect of an entrenched decline in prices stalks the entire currency bloc and not just Spain, he said.

Deflation, a downward spiral of prices that spreads to wages, can wreck economies. The most striking example in the 20th century was the Great Depression.

Euro-area inflation has been below zero since August as the coronavirus pandemic crushes demand, and underlying price growth excluding volatile items is at a record low.

While the ECB predicts that consumer prices will rise again early next year, it’s also planning to “recalibrate” its stimulus in December and has called on governments to step up fiscal spending.

“We are seeing an increase in the portion of goods whose prices are increasing very little or falling, which is an indication of the risk,” Arce said. Bank of Spain Governor Pablo Hernandez de Cos has expressed a similar concern.

Read more: ECB’s De Cos Says Deflation Risk Warranted More Stimulus

Arce acknowledged that the outlook for the ECB and policy makers around the world was somewhat brightened on Monday when Pfizer Inc. and Germany’s BioNTech SE said their vaccine is showing “extraordinary” progress.

Still, the ECB was already banking on a medical solution being found next year.

The vaccine news “somewhat reduces the downside risks” to the economy, Arce said. “But we know that it’s not a solution in the very short term. We know that it will still take a while before the vaccine can be widely distributed.”

Changing the Goal

In the longer term, officials should consider a Federal-Reserve style strategy that allows inflation to temporarily rise above their goal, he said.

That’s a topic the central bank is currently reviewing, and has been flagged as an option by President Christine Lagarde, as well as Hernandez de Cos.

The current goal is “below, but close to, 2%” — and Arce said a specific target, such as 2% would reduce some of the ambiguity and the risk of misinterpretation.

Some economists have expressed doubt that the ECB will be able “overshoot” a target they haven’t come close to hitting in years.

“It will be credible as long as the Governing Council is capable of convincing all agents of its determination to implement this strategy,” Arce said. “I have no doubt it is capable.”

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