Interview with Bloomberg
Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Jana Randow, Carolynn Look and Alexander Weber on 30 November 2020
1 December 2020
ECB staff are currently working on new projections. From today’s perspective, what do you expect them to show, and how much of an impact will the vaccine have on the economic outlook?
At the moment we’re seeing two countervailing forces. On the one hand, there are rising infection numbers and renewed lockdowns. This has tilted our outlook to the downside. On the other hand, there’s positive news on the vaccine. This shows that there is light at the end of the tunnel. But of course, we still have to get through the tunnel, so that’s the challenge we’re facing. If we look at the data, we have seen a surprisingly strong rebound in the third quarter, but we also see now that the fourth quarter is very likely to show a drop in GDP, even if the situation is not as severe as in the spring. It seems likely that this weakening is going to stretch into the next year, and also that the inflation outlook may be subdued for some time. We continue to work with scenarios, and one of the main driving factors is how quickly the medical solution will come about. It’s likely that the overall recovery will be bumpy. We may see renewed lookdowns until widespread immunity has been achieved.
What does this mean for policy in December? We’ve seen the message being muddied in the past days. You’ve put a big focus on duration in the past weeks that has kept expectation for a bigger boost at bay. What are we to expect? A grand package or more of a measured approach?
That has to be decided by the Governing Council. It’s important to acknowledge that we have already achieved quite a lot. Financing conditions are historically low. This provides substantial support to the economy. We should now focus on preserving these favourable financing conditions for as long as necessary in order to support the recovery, reduce the potential scarring effects and counter the negative impact of the pandemic on the inflation outlook. Given the high degree of uncertainty we’re still facing in the economy and the already very favourable financing conditions, I think it is appropriate to focus on preserving these conditions rather than easing much further. Duration is the crucial aspect. Markets, firms and households need to understand that we will be there for as long as necessary. This is the key part in my view.
How will you determine the right level of financing conditions? Are you saying that bond yields right where they are now is the right level?
This would have to be discussed. Current levels provide substantial support to the economy.
There are various ways of achieving that. The most explicit way is yield curve controls, which the ECB has rejected up until now. Is that something that you could be explicit about?
We have never discussed yield curve control in the Governing Council since I've been here. That doesn’t mean that we’re not going to discuss it at some point in the future, but I don’t think that explicit yield curve control with quantitative targets is on the table at the moment.
How is targeting a spread or a level of financing conditions any different?
With yield curve control, a central bank commits explicitly to keeping yields at a specified level. Then it does whatever it takes to keep the yield at this level. This is a very explicit commitment. Preserving financial conditions is a somewhat broader concept.
What’s always on the top of our minds is our main goal: the inflation objective. This plays the dominant role in our deliberations. Where we do have some flexibility is the time horizon over which we get back to the inflation aim. The optimal horizon depends on the circumstances and the types of shocks we are facing. In a situation like today where – already before the pandemic – the economy had been hit by long-lasting structural shocks that continue to have a disinflationary impact, it may take longer to achieve our aim. This is not about complacency. We’re fully committed to that aim but the lags in monetary policy transmission vary with the state of the economy.
Inflation expectations as measured by financial markets have been stable since August between 1% and 1.2%. That’s too low but at least stable. Are you happy with inflation expectations at this level until the pandemic is over?
We are not happy with that level of inflation expectations. This should be absolutely clear. We would be very happy to see market expectations rise. But it’s not only about market-based inflation expectations. Other types of inflation expectations also matter: what do firms and households expect? These expectations are often very different from what we are seeing in markets. This is one important issue that we’re going to discuss in the strategy review.
The market is looking for around about 500 billion euros more of PEPP, plus more TLTROs with potentially looser conditions. Do you feel that’s what you have to do because the market expects it?
We do not feel obliged to do what the market expects from us. We are guided by our mandate. There are a number of important parameters that we can change. It’s not just the amount, it’s also the duration. And it’s about communication. What’s clear is that since the beginning of the pandemic, the PEPP and the TLTROs have proven highly effective. Therefore, these are likely to be the main instruments for our recalibration.
Are you comfortable with expectations for an increase in PEPP purchases of 500 billion euros and extension by six months?
The expectations are there. We have to take our decision in line with what we think is appropriate, and this is what we’re going to do. If it’s necessary to do something that does not meet market expectations, we have to do that nevertheless. We always stress that our decisions are data-driven and an important input to the decision-making process, our projections, are still being finalised.
You emphasised the point of duration. If there were a proposal that instead of increasing the PEPP for six months, that you were to extend it for 12, is that something that you personally would support?
We will look at all options.
The PEPP is set to run as long as inflation has resumed its pre-pandemic path. But since the financial crisis, we haven’t really seen that recovery in inflation that was expected. What convinces you that bond purchases are the right tool to make that happen this time?
Whenever we are calibrating our instruments, we do a lot of analysis to find out how effective they are. If we look at the joint effect of the asset purchases and TLTROs since March, our calculations show that they are expected to have a cumulative effect on inflation of 0.8 percentage points and on growth of 1.3 percentage points between 2020 and 2022. This is a substantial effect, and therefore, we are confident that these instruments actually worked well in the past. What we have to assess now is whether we expect the same to be true for the future. One has to acknowledge that the situation now is different from the situation we were facing in March. In March we were facing severe market turbulence. At the moment, fortunately, markets are very calm. Therefore, it’s less about market stabilisation and much more about the stance function of these instruments.
On the question of how can we get back to the pre-pandemic path, the longer the pandemic lasts, the more blurred this concept becomes. In the end we will have to get back to our inflation aim.
Are interest rate cuts off the table for December?
We have always said we will consider all instruments, and we will do a cost-benefit analysis of all the available instruments and possibly new ones. We are looking at the effectiveness of the instruments, potential side effects, complementarities between instruments and so on. So far in the pandemic, the combination of the PEPP and TLTROs has worked very well. In the past we decided against further interest rate cuts. That doesn’t mean that we won’t cut interest rates in the future if there are changes in our assessment that justify such a step.
You have several hundred billion euros left under PEPP. If you were to do the analysis independently of what the market expects, would you come to the conclusion that you actually need an increase in PEPP now, or could you ramp up purchases later if necessary? Do you feel like you have to come up with an increase to satisfy expectations?
If you think about our previous decision, it was taken at a time when there was no second wave yet. Now we’re experiencing a second wave in Europe and other parts of the world. This seems to suggest that, even with news of the vaccine creating a lot of hope, the pandemic will be more protracted. I think this has to be reflected in our policy decisions. For the previous decision, we had assumed that the pandemic period would extend until June 2021. Now this may appear too optimistic. In fact, we have to distinguish between the health crisis and the economic crisis. A fairly positive scenario could be that by the middle of next year we are seeing the start of widespread immunity and we’ve managed the health crisis. But the economic crisis will take longer than the health crisis. There will be economic ramifications even once the health crisis has been overcome. What matters for our monetary policy decisions are mostly the economic effects.
The PEPP is explicitly slated to run until the crisis phase is over. Which yardstick would you use to define the crisis phase, and how long do you think it will last?
We have not defined any quantitative criterion for the length of the pandemic crisis phase. At this stage, it’s impossible to say when it will be over. Therefore, we’re taking a step-by-step approach. If we now come to the conclusion that June was too optimistic, then this would lead to a prolongation of the pandemic crisis phase, without necessarily linking that assessment explicitly to a quantitative criterion.
At some point, of course, we’ll have to ask ourselves whether the very long-lasting effects are still part of the pandemic crisis phase. At some point there has to be a transition from the crisis phase to a more normal situation, even though there may be scarring in the economy. When defining the pandemic crisis phase, you cannot include all scarring effects that may occur, because they may last very long. My hope would be that if the vaccine can be rolled out relatively quickly then maybe also the scarring effects can be limited. But this is something that we don’t know yet. The balance sheets of firms are now more fragile than they were in the first wave and that may mean that the scarring effects may be more important.
The Governing Council has said that, for the PEPP, the ECB will reinvest the bonds until the end of 2022. But right now we're talking about an extension, and when that time comes, this portfolio will be very large. When do you need to start talking about the longer-term plans for reinvestment and what happens after 2022?
In principle it can be done at any time before the end of the reinvestment period. We have to monitor how the crisis evolves and, in response to that, all the parameters of the purchase programmes can be adjusted.
We’ve talked a lot about the PEPP in addressing all of those issues, but you also mentioned TLTROs as an important part of the package. At the moment the effective interest rate on the TLTRO is minus 1%. Do you think the ECB has reached a lower bound there or is there more leeway?
I don’t think that minus 1% constitutes a lower bound; there’s no technical reason why this could not be lowered further. The question is whether this is considered appropriate. Right now the TLTROs are highly favourable. If we come to the conclusion that the pandemic crisis phase takes longer than originally thought, this could also have an impact on the calibration of the TLTROs. The TLTROs are an important part of our toolkit because they are protecting the bank lending channel, which in our bank-based economy plays a very important role. The targeted character refers to the fact that the extremely favourable rate is linked to a particular lending threshold. This has worked very well in the past and it may also work well in the future.
Are you saying TLTROs are more or less generous enough, and the interest rate can but doesn't necessarily have to be lowered, but we need them for longer?
This is something which will have to be discussed in the light of the projections. What I said is that the duration of our main tools should be linked to the duration of the pandemic crisis phase, and this would refer both to the asset purchases and to the TLTROs. There are many parameters that could be adjusted: there’s the duration of the operation, there is the period of the reduced rate, and also the number of operations.
How about increasing the maturity of TLTROs to five years or something like that?
I don’t think that’s the key point. Three years is already quite long.
In one of your last speeches you talked about financial stability risks related to too much stimulus, and you’re talking a lot about duration now. Central bankers always say they can do more if needed, but given the constraints we see, does the ECB actually have the means to meaningfully bolster inflation and bring it back to its target, or is preserving conditions actually the best you can do at the moment?
Preserving financial conditions is what we should do at the moment. There is always an assessment of the benefits and the costs, and there are many things that enter such assessments. What we can steer most effectively are financial conditions. The question is how changes in financial conditions translate into real economic activity. Let’s say we are in an environment of very high uncertainty – then, the same change in financial conditions may have a smaller impact on real activity than at a time when uncertainty is smaller. Potential side effects also enter the cost-benefit assessment. And then you have different parameters. One can adjust the intensity of the measures, but one can also adjust the horizon. The “medium term” is not a fixed concept, it can be adjusted, and then the question is what the appropriate length of the medium term is in specific circumstances.
In the second quarter, household saving rates reached record levels. Based on what happened in the third quarter and now the second wave of infections, do you think savings will fuel the recovery next year or is there any reason to assume the dynamic will be different this time?
There will be a certain degree of pent-up demand. This will support the recovery. But we also know that the sector most severely hit by the pandemic, the services sector, is probably the one that’s going to benefit least from that, because there’s a limit to how often we can go to the restaurant, the hairdresser, go on vacation and so on. It’s a major theme of this pandemic that its economic effects are so uneven, that it affects different sectors and therefore also different countries to very different degrees – and of course different people. There’s the fear that this pandemic will lead to higher inequality.
During this crisis the ECB got a lot of help from the fiscal policy side, and President Lagarde mentioned today how much of a game changer the EU’s recovery fund is. It’s now being held up in a pretty fundamental debate over the rule of law. What does it mean for the ECB if the plan isn’t finalised?
In this crisis, monetary and fiscal policy have acted in a complementary way, as they should, and thereby they have reinforced each other. That was very beneficial and it’s pretty clear that this should continue for quite some time. So neither the fiscal support nor the monetary support should be withdrawn prematurely. The European fiscal response was a game changer. We had a strong national response already, but then on top we had the European response, which also had a signalling effect by showing that Europe can act together when it’s needed. When it comes to the conclusion of the negotiations about the Next Generation EU instrument, it’s absolutely crucial that they are concluded as soon as possible. But I am optimistic that an agreement can be found.
We’re looking at more monetary stimulus for a very long time. Has the ECB succumbed to fiscal dominance?
I do not think there is a problem of fiscal dominance at the current juncture. There is really no alternative to the rising public debt levels that we are seeing, because at this stage fiscal policy is clearly the main stabilisation instrument. It’s also likely to be highly effective, because we know that when monetary policy gets closer to the effective lower bound, fiscal policy becomes more effective. What is absolutely crucial for the development of the euro area economy over the coming years is how public funds are employed in the end. It makes a huge difference whether these funds are used for productive investments, like the green transition, digitalisation, education and infrastructure, or not. It has an impact on monetary policy, too, because a good use of investments may also give a boost to the real natural rate of interest by increasing productivity, which would give monetary policy more space. It also matters greatly for future debt dynamics, because those will hinge on growth in the euro area, and that depends on fiscal policy allocating these funds in a sensible way.
We all know what a debt crisis looks like in Europe. And there will come a point when the euro area economy will improve, when inflation will pick up and when we will look at an Italy with a debt-to-GDP ratio of at least twice if not more the level allowed under Maastricht. Are you willing to say the ECB will tighten policy if the euro area as a whole demands it, knowing that countries like Italy and Greece will have a problem with that?
Interest rates are extremely low at the moment and so the debt-to-GDP ratio may not be the only metric to look at. What really matters is the debt service as well as economic growth. We have also seen that the maturities of government debt have lengthened, which partly protects governments against increasing interest rates. In any case, an increase in the interest rate will never affect all debt at once but only a portion of the overall government debt.
We have an inflation aim of below, but close to, 2%, but we already now stress in our introductory statements that there is a commitment to symmetry. And that means it will not happen that once the inflation rate crosses a certain threshold we will immediately fight against the increase in inflation. We have always stressed that what we would need to see is a sustained increase in inflation. And if you see such a sustained increase in inflation, it’s likely that this reflects an overall more robust economy, at least if the shocks are coming from the demand side. With supply-side shocks it’s a bit more difficult. But then again, we have the “medium term” concept, which helps us to deal with supply-side shocks.
It’s quite hard to know what’s going to happen in the future, but at the moment, we seem to be on track towards a vaccine and the ECB’s assumption of a medical solution in the middle of next year, and in a year’s time, hopefully the pandemic is over. Do you think it’s likely that this meeting in December is the ECB’s last big push and after that it’s just managing the crisis and eventually coming out of it?
That would be good news. I indeed hope this will be the last big push, but we can never know what’s going to happen. There is a positive scenario where we get a swift recovery and the scarring is relatively limited. But there is also the risk of the crisis being more protracted. In any case, we know there will be structural changes. Not all of those structural changes are bad news, but a structural change always creates disruption, especially for labour markets, so it’s very hard to predict.
Mario Draghi never raised interest rates in his entire term. Do you think you’ll ever see policy tightened while you’re on the board?
I’m not good at predicting that. But I would hope that at some point this will be possible. We shouldn’t take for granted that interest rates will remain low forever. There is no law of nature that tells us interest rates have to stay low for the next decades, and if we look at economic history, we see that there were different periods and people often thought they would last for a long time, but they came to an end at some point. This may also happen this time, but it’s of course hard to predict. Within our projection horizon, it’s hard to see that, but my term is longer than our projection horizon. So there is some hope.
Let us talk now about climate change policies. It seems that disclosure requirements for bond issuers and credit ratings that include climate risks have emerged as the two main instruments through which you want to address climate risks and green monetary policy. What’s the timeframe in which this is realistic?
No decision has been taken on this. The proposals you mention seem quite plausible, but it has never been discussed in the Governing Council. In the monetary policy strategy review we will seriously consider this topic. But of course this will be a longer-term project because it has so many facets. It concerns our whole model apparatus, where we plan to include climate risk. Then there is the question of how we assess climate risk on the balance sheets of firms and banks, what this implies for financial stability and so on. Each of them is a big project. Another big topic is how climate change can influence our monetary policy operations. Disclosure is attractive because there the central banks can play an important catalyst role. Whatever we want to do to deal with climate change – and not just us but also other market players – relies on data. For that we need two things. First, we need a taxonomy, that is a classification of what is green and what is less green. Second, we need a disclosure of the information by the firms to be able to judge how green some activity is. This information has to be available first. It’s a prerequisite for everything else that can come later.
We’re having a very big debate about climate change and what central banks can do and you’re telling us that the Governing Council has not addressed this once?
This is going to be discussed in the context of the monetary policy strategy review. The strategy review is a broad-based process. A lot of analytical work is going on in the background, with many papers being written, analyses being done, data being collected and so on. And then the Governing Council discussion is the end of that rigorous process.
Should it be?
It’s a very well-established procedure that we first conduct the analysis and then we have the discussion. This is what is done with all the other topics as well. The difference is that with respect to climate change, there exists less work that we can draw from than for, say, the price stability objective or fiscal policy, which have been discussed for decades. This is why this topic is more demanding and it’s perfectly clear that central banks will have to put much more resources into this area in the future. In the past, the topic was more or less non-existent, so this is something that has to be built up, also the intellectual capacity has to be a built up. There are by now quite a few people working on this topic. It’s a structured process but it takes some time.
There are a couple of banks, JP Morgan among them, who predict that 2021 will be the first year when more ESG bonds will be sold in dollars than in euros. Do you expect the U.S. to surpass the EU in issuing that kind of debt?
It would be excellent news if more green bonds were issued in US dollars as well. One of the hopes that people attach to the incoming US President is that he’s going to put more emphasis on the green transition and that of course also requires the greening of the capital market. It would be more than welcome if the US capital markets also became greener. Climate change is a global challenge that requires a global response. The European capital market should seize the opportunity and expand its position further. In Europe, the project of the capital markets union should be combined with the greening of the capital markets because the two naturally go together and this could help to develop and maintain a strong position.
Do you expect the green premium in bond markets to continue next year?
That’s an open issue. We still have very little research on that. We have to see how that market develops. We will certainly see a lot of progress in this whole market segment with much better classifications and ratings. At the moment, ESG ratings are still not as reliable as they should be. They are sending diverging signals, depending on which data provider you consider, and therefore also the market pricing may change when this market matures and the information basis becomes better.
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