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Interview with Der Standard

Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Andras Szigètvari on 7 January 2021 und published on 12 January 2021

12 January 2021

Is there still such a thing as inflation?

Inflation is not dead. Compared with the long course of economic history, inflation has only been as low as it is now for a relatively small number of years. And just because we are now in a phase when a particular phenomenon does not appear is no reason for assuming that it no longer exists.

What evidence do you have for this?

The fact that inflation has been so low for several years is mainly due to structural changes in our economy. Globalisation, especially China’s entry into world trade, has increased the global labour supply, while reducing employees’ bargaining power and therefore wage growth. That has exerted downward pressure on prices. Moreover, digitalisation has brought more price transparency and so more competition, just think of online shopping. Demographics may play a role too: owing to the ageing of western society, people have on average saved more while investing less. But these factors may change again.

What would cause them to change?

Some economists, such as Charles Goodhart, argue that inflation will increase markedly again because these factors could reverse. Demographic ageing could reduce the global labour supply, wages could rise and globalisation could abate. People who have put money aside for their old age could begin to spend more, without the supply of goods expanding to the same extent. In addition, digitalisation has led to an increase in market power in some areas. But such longer-term trends are extremely difficult to predict and things may also turn out differently.

In recent times the ECB’s projections have always been wrong: for years it has been predicting a rise in inflation, but that has never come about.

The past few years were a very unusual time. The economy was subject to a whole series of disinflationary shocks. First came the financial crisis, then the euro crisis. Such shocks are not captured in the models. The pandemic has now pushed inflation further down over the past few months. But we expect that will change and that, relative to the current negative levels, 2021 will see an increase in inflation.

Why is that?

The decline in energy prices was a major reason for the sharp fall in inflation in 2020. The temporary cuts in VAT also had a downward impact, especially in Germany, because that country has such a large weight in the index. The tax cut in Germany has now expired. And we should soon see a robust rise in energy prices relative to last year, because the prices were so low in the spring of 2020.

But will this be more than a flare-up of inflation?

Some momentum may well arise in the shorter term. Imagine if the vaccinations are completed more rapidly than some people now fear, enabling some return to normality in the summer. The prices for services, such as travel or eating out, may soar on the back of the pent-up demand. But such a short-term development should not be mistaken for a sustained increase in inflation, which is likely to only emerge very slowly. That is why it would not significantly influence our monetary policy decisions, which are oriented towards a medium-term horizon.

Consequent on the pandemic, the ECB will create €1.85 trillion in central bank money for the purchase of sovereign bonds. But unlike in the financial crisis in 2008, the banks are now assiduously issuing loans. The money supply is expanding. If inflation is not dead, will that not have profound effects?

At present there are no indications that we need to be concerned about inflation being too high. We see a pronounced weakness in demand. There is a danger that the crisis will have a scarring impact on the labour market. All in all, the main problem is probably that economic demand is too weak, rather than that capacity bottlenecks may arise, which is why prices are more likely to rise too slowly.

During the crisis, the ECB, through its many market interventions, has “gained a great deal of power, even though it is subject to hardly any parliamentary control”. This quotation stems from an interview with you in 2017. How do you see things today: during the pandemic the ECB has again gained significantly in importance?

The ECB is independent of politics, but it is bound by its mandate. For the ECB’s actions to be legitimate, it is essential that they are within its mandate and proportionate to that mandate. At the time of that interview, I made the point that in earlier crises the ECB had been left on its own by fiscal policy. Fortunately, today things are different. The pandemic is the deepest economic crisis the world has experienced since the Second World War. In such circumstances, all economic policy actors are called upon to take extraordinary measures. If you look at the financial market data from March 2020, you can see that we were heading into a severe financial crisis. The ECB succeeded, in tandem with fiscal policy, in preventing that financial crisis and an even harder economic downturn.

But what do you say to people who feel queasy about this amount of money and warn that it has got to have an impact?

The dilemma for the ECB and other central banks is that, owing to structural factors, we are confronted by a long-term decline in the general level of interest rates, as a result of which we have reached the limits of conventional monetary policy, i.e. interest rate policy. In such a situation, a central bank has no choice but to turn to other instruments, such as bond purchases. Only government policy can provide a remedy by ensuring sustainable growth and stimulating investment. Then the general level of interest rates will also rise again.

So governments must spend more?

Yes. But it’s not just about spending more, but about spending in the right way. Productivity and potential growth must be fostered. Simply raising transfers won’t help.

You are a German economist; in your country there was strong support for the “black zero” balanced budget dogma. Now you say governments must spend more.

Even in Germany there is widespread consensus that public spending and debt need to be increased during the pandemic. It would be a massive error to reduce spending or, in the middle of the pandemic, to begin saving because of concerns about increased debt. The question of public debt sustainability depends to a large extent on balancing interest rates and growth prospects. As long as growth is higher in the longer term than interest rates, there is no problem. So, if you want to reduce debt after the crisis, the best instrument is the promotion of economic growth.

In the euro area there are strict rules on debt and deficits. Does that mean these numerical targets are obsolete?

Those figures are not based on economics; they were political decisions. With low interest rates, sustainability is higher. More important than the specific figures, however, are the mechanisms of the fiscal rules. The current rules are too strict in bad times and too lax in good times.

According to modern monetary theory, the only limit to debt is inflation. Because that doesn’t appear to be a problem at present, you can spend handsomely. What is your view on this?

In modern monetary theory (MMT) it is, ultimately, disputed whether governments are subject to budget constraints at all. That is certainly not my perspective. When the pandemic is over, governments will need to create fiscal room for manoeuvre for future crises. One thing we have seen is that a country like Germany was in a relatively comfortable position because it had previously created fiscal space. However, one must be careful not to start consolidating too soon. That would be the biggest economic policy mistake that could be made – tightening monetary and fiscal policy too soon.