Zero rates not a policy floor, says ECB's Orphanides

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Central bankers can continue to ease monetary policy even when interest rates are at zero, and should do so if they sense the threat of deflation, a member of the European Central Bank's Governing Council said on Saturday.

Athanasios Orphanides said in prepared remarks to a monetary conference sponsored by the Federal Reserve and the ECB that the nominal level of interest rates means nothing if policy-makers ignore the underlying level of prices in the economy.

"The degree of monetary policy ease should be associated with the level of real interest rates, not nominal interest rates," said Orphanides, who also is governor of the Central Bank of Cyprus.

"Near-zero policy rates that may be considerably expansionary in an economy with high inflation could be contractionary when inflation is too close to zero, or worse, deflation has set in."

Orphanides added that the greatest contribution monetary policy can make to financial welfare is maintaining price stability, thwarting not only inflationary risks but also deflationary ones.

The EBC member's comments were aimed largely at an audience of academic economists. He praised the world of policy research for laying the groundwork for many of the unconventional policies undertaken by central banks around the world, which Orphanides credited with preventing even worse economic outcomes.

"The decisive policy easing by the Fed and the ECB during the crisis, and the adoption of unconventional measures by the two central banks, was crucial in countering the threat of deflation in the current episode," he said.

The US economy has recently emerged from its worst recession since the 1930s, though unemployment remains historically elevated.

The euro zone's economic recovery has been more tentative. The gross domestic product of the 16-country currency area edged up just 0.1% in the October-December period compared with the previous quarter, and contracted by 2.1% from the last quarter of 2008.

Most recently, the outlook for Europe has also been clouded by a crisis of confidence in the highly indebted government of Greece.