European Central Bank governing council member Athanasios Orphanides spoke with Dow Jones Newswires reporter Nina Koeppen. The conversation took place in his office on the 33rd floor of the ECB tower in Frankfurt on Thursday, following the ECB’s policy-setting meeting. Born in Cyprus and educated at Massachusetts Institute of Technology, Orphanides was on the U.S. Federal Reserve staff from 1990 to 2007. Below, the transcript of the interview.

Orphanides: Before I’ll get to your questions, let me please comment on an article in Thursday’s Wall Street Journal that presents survey results about default or restructuring by Greece and other European countries. The article reports that most of the respondents are American economists and I think the results reflect a lack of understanding of how the European Union and the euro area function. There is an element of absurdity in talking about a high probability of default by the Greek government right now [73% according to a survey by The Wall Street Journal]. A European Union support plan is in place. Over the past three months, the Greek government has taken very decisive measures to control public finances. We now have concrete evidence that the Greek government’s fiscal consolidation plan is on track. Take a look at the latest numbers reported by Finance Minister Papaconstantinou: Over the first five months of 2010, government revenues increased by about 8% while government spending was cut by more than 10%, compared to the year before. This is evidence why one should be much more confident about Greece today.

Dow Jones: Investors are also concerned about public finances elsewhere, such as in Portugal and Spain. Are governments doing enough to get public finances back on a sustainable path?

Orphanides: We have seen decisive actions by a number of governments, including the governments you mention. These regard fiscal consolidation and also structural reforms that are essential to improve prospects for higher growth and employment over time. These efforts are in the right direction and should be applauded.

Dow Jones: Will the need for fiscal consolidation eventually split the euro zone in two inflation-wise: Periphery countries facing deflation, others inflation?

Orphanides: I don’t see that. In the euro area, we have one economy with one currency. That’s why we cannot have permanent deviations in either prices or nominal wages that are not justified by differentials in productivity. Temporary deviations may occur and may last for a few years. We must carefully monitor the relative competitiveness of different economies in the euro area. But, what I have in mind, is a more effective monitoring of competitiveness measures, such as relative wage developments, relative price developments and productivity differentials. .

Dow Jones: Could you please specify what you mean by “a few years”, especially as the ECB targets a medium-term horizon?

Orphanides: Divergence that cannot be explained by relative productivity differentials could create difficulties and require adjustments. That’s what we have seen in some euro-area countries in the past few years. The adjustment process may take a while, but will be beneficial over the longer term. I note that this is an adjustment of relative prices and wages within the euro area while the ECB’s objective is to maintain price stability in the euro area as a whole.

Dow Jones: You’ve just said the euro zone needs more efficient monitoring. Please elaborate.

Orphanides: The euro area would clearly benefit from more effective economic governance. Improvement could be pursued in a number of dimensions and include the improved surveillance of various factors: The surveillance of nominal indicators–such as relative wage developments and relative price developments that may indicate the building up of divergence that cannot be explained by productivity differentials. Perhaps the most crucial item that has revealed itself in the current episode: We need to strengthen the mechanism of fiscal surveillance and enforcement to ensure compliance with the rules of the monetary union. We must do that much more effectively than in the recent past.

Dow Jones: What kind of institution would carry out the surveillance? Would that institution also be able to enforce better governance?

Orphanides: President Trichet recently said a “quantum leap” would be desirable in economic governance. We can think of a number of areas where the mechanisms could be strengthened. One attractive idea is the creation of an independent fiscal agency that monitors and assesses fiscal policies across the euro area. We must improve the incentive mechanisms for governments to control their finances. That also requires a more effective mechanism for imposing sanctions in case of noncompliance. Some of these ideas may require fundamental changes, but they are worth considering as they promise to improve the functioning of the euro area with substantial long-term benefits for all.

Dow Jones: What would an independent fiscal agency look like? It must surely be independent of political pressures.

Orphanides: One idea is the creation of an independent agency within the European Commission, which is already independent of governments. It is essential to strengthen the mechanism for something as simple as the collection of reliable data. The past few years have demonstrated that the current mechanism does not always ensure the reliability of fiscal data reporting. A better data collection and validation mechanism is needed to help the Commission assess the fiscal position of member countries.

Dow Jones: Does that mean the EU Commission should get greater powers?

Orphanides: Depending on the situation, it may be desirable for a European Union body to have the power to be more intrusive in order to get the information needed for effective governance. It may also be desirable for the agency to have the power to enforce better fiscal governance by imposing sanctions to discourage misbehavior.

Dow Jones: What role would the ECB play in all that?

Orphanides: The ECB is already a European institution and one that works very well. The primary role of the ECB is to ensure price stability in the euro area. But clearly, we would support the political discussion on improving economic governance in the euro area as best as we can. Strengthening economic governance in the euro area is of the utmost importance to prevent a similar crisis occurring in the future. It should be high on the euro area’s political agenda.

Dow Jones: What’s at stake if politicians don’t get their act together?

Orphanides: Our economic union offers much greater potential for improving economic well-being for all European Union citizens than is currently being realized. Unless we strengthen the foundations of the euro area, we will fail to realize fully the benefits of greater economic integration and interdependence and will forego a higher growth potential. We will also fail to improve the resilience of our economy in addressing challenges that can evolve into costly crises. The tensions experienced throughout the euro area as a result of the recent Greek situation serve as an illustration of these costs. The absence of a robust crisis management framework led to a considerable delay in addressing the problem by the European Union, which rattled market confidence and raised the costs of dealing with the underlying problem. In the aftermath of the crisis, I am confident that the political leadership of the European Union will rise to the occasion, as has happened at critical moments in the past, and act towards a more integrated and strengthened economic and monetary union.

Dow Jones: Why does the ECB purchase Greek sovereign debt now that the EU’s 500-billion-euro plus stabilization fund is being set up? Or, to put it differently, will the ECB stop buying sovereign debt once the fund becomes fully operational later this month?

Orphanides: The ECB launched its Securities Markets Program to address severe tensions in certain market segments that hampered the monetary transmission mechanism. I could envision that, when the European Financial Stability Facility is fully operational, there will be improvements in the market segments that have not been functioning well over the past several weeks. Clearly, once these improvements are in place, there would no longer be a need to continue with a specific program. That’s why the ECB is constantly monitoring the situation.

Dow Jones: Turning to the Eurosystem’s staff forecasts published Thursday: Is the latest upward revision in the inflation outlook only a temporary development, or does it signal a change in the interest rate cycle?

Orphanides: The current inflation projections are quite benign. They do not indicate risks of breaching our price stability objective. The inflation projections for 2011 also paint a rather benign picture–with an inflation estimate of around 1.5%. What’s important is that the upward revision in the inflation forecast is primarily driven by energy and other commodity price increases. It does not reflect an underlying inflation concern. Indeed, core inflation in the euro area has been trending down. In light of these developments, I do not view high inflation as a concern. Also, and most importantly, inflation expectations over the medium to long term have remained very well anchored, in line with our objective of price stability.

Dow Jones: Is the weak inflation outlook partly a result of slack domestic demand?

Orphanides: Indeed, if you look at the Eurosystem staff forecasts, then private consumption growth should remain fairly weak. That’s one of the reasons why Eurosystem staff do not foresee significant risks of underlying inflation picking up. This is how I interpret the staff forecasts.

Dow Jones: Is the euro-zone’s economic upswing robust enough to cope with rising money market rates?

Orphanides: We are sensitive to the liquidity needs in the banking sector. Currently the ECB supplies as much liquidity as demanded by the banking sector in order to defuse any concerns about the availability of liquidity. With a fixed-rate, full allotment procedure for the three-month operations for the third quarter already announced, the ECB has ensured that banks will have available as much liquidity as needed through the end of the year, and we are still in June.

Dow Jones: Did you discuss at the Governing Council meeting the launch of a new six-month tender?

Orphanides: We are continuously monitoring conditions and, as President Trichet said in the introductory statement, the overall provision of liquidity will be adjusted as appropriate.