Interview with Nikkei
Interview with Fabio Panetta, Member of the Executive Board of the ECB, conducted by Jun Ishikawa
26 May 2021
What’s your assessment of the current economic situation in the euro area? Philip Lane said that we are now at an inflection point…
The lesson from last year is that we should be careful about declaring victory too soon. We received positive data over the summer, everybody was celebrating the end of the pandemic, and we know how that turned out: the economy went into a double-dip recession.
The outlook is now improving. We expect a rebound in the second half of the year, supported by the acceleration in vaccinations, the firming of global demand and, domestically, by the deployment of Next Generation EU funds. The recovery in tourism flows, which hopefully will last more than a couple of months like last year, will be emblematic of a gradual normalisation.
But there are two points to keep in mind. First, the recovery is incomplete: euro area GDP is still 5.5% below its pre-pandemic level and even further beneath its pre-crisis growth trend. This means that millions of jobs lost during the pandemic have not been recovered.
Second, the economy still relies on the oxygen provided by both monetary and fiscal policy: we are far from the point where we can see self-sustained growth. For example, job retention schemes continue to play a major role: in the euro area, the share of workers who are unemployed, discouraged or enrolled in such schemes is around 17%, double the headline unemployment rate.
It will take time to see how the economy will exit this terrible period and the real damage it has left behind. There's also still a lot of uncertainty, as you can see from consumers’ prudent spending behaviour and high precautionary savings. If you have a job supported by your government, you can make a living today, but you would naturally be worried about your job in the future.
In such an environment, a premature withdrawal of policy support would risk suffocating the recovery before it becomes self-sustained. And it would exacerbate uncertainty, further weighing on demand.
So we must continue to closely monitor the incoming data and ensure that the exit from the crisis is supported by a robust and lasting recovery. The output gap, the employment gap and the inflation gap are the key variables to determine when we have truly gone beyond the pandemic phase. They are expected to gradually narrow, but they are still far from satisfactory.
We are not out of the woods yet …
No, absolutely not.
What is your inflation outlook? Euro area annual inflation increased to 1.6% in April. It looks like inflation is coming back, doesn’t it?
We are currently seeing a transitory increase in inflation driven by rising commodity prices at the global level, statistical base effects and the reversal of the German VAT cut. But this will be a temporary hump: it is not expected to last beyond this year, as it’s not self-sustained and it’s not domestically driven. In any case, underlying inflation, which is mainly driven by domestic services, remains very low, at 0.7% in April.
Looking further ahead, our March projections foresaw that medium-term inflation would remain subdued: only 1.2% in 2022 and 1.4% in 2023. We should not extrapolate from what is happening in the United States. We don’t expect the same kind of surging demand and tight labour markets that would generate stronger lasting price pressures. Recent inflation surveys are in line with this picture.
I am concerned by the fact that, over our policy horizon, inflation is going to remain well below our objective of 2%. This may affect our credibility after so many years of inflation “misses”. Moreover, too-low inflation aggravates the real cost of debt at a time when private and public debt ratios are rising in order to offset the collapse in income caused by the pandemic.
Why does it take such a long time to return to 2%? Can we call it Japanification?
Japanification is the wrong expression in my view. It describes a situation where inflation expectations re-anchor at very low levels and become hard to dislodge. That’s not what we see in Europe. Long-term market-based inflation expectations are still around 1.6%, which is not optimal but a sign that the situation is very different from Japan.
What we’ve had is a sequence of huge shocks. First, the great financial crisis. Then the euro crisis. And now the pandemic. But the European Central Bank (ECB) can bring inflation back to its objective. We have the tools to push inflation close to 2%. And there is general agreement in the Governing Council that the current levels of projected inflation are unsatisfactory.
It is clear to me that the level of inflation in the medium term is still decided by the central bank. And we need to preserve our credibility, continuing to act forcefully until we reach our objective.
I would like to move on to monetary policy. Should the ECB continue after June to purchase bonds under the pandemic emergency purchase programme (PEPP) at the same pace as it does now?
The objective of the PEPP is to maintain favourable financing conditions, which are crucial to supporting spending by both the public and private sectors. With demand still weak and underlying inflation at very low levels, policy support remains essential and a premature tightening in financing conditions must be avoided. The risk of providing too little policy stimulus is still high.
In my view, only a sustained increase in inflationary pressures, reflected in an upward trend in underlying inflation and bringing inflation and inflation expectations in line with our aim, could justify a reduction in our purchases. But this is not what we projected in March. And, since then, I have not seen changes in financing conditions or the economic outlook that would shift the inflation path upwards.
In fact, we are now seeing a further undesirable increase in yields after the rise we observed earlier in the year. Financing conditions are tightening. In this environment, it is not surprising that we have also seen a persistent, non-negligible appreciation of the exchange rate, which – if sustained – would weaken inflationary pressures. We will discuss the implications of these trends in our June meeting, especially in the light of the new projections for medium-term inflation.
Would it be very difficult to end the PEPP by the end of March 2022 as scheduled?
I can’t currently speculate on what we will do in March 2022. That is almost a year from now, and a year is like a century today, given the high degree of uncertainty.
And let's not forget that we did not say that we would end purchases in March unconditionally. The Governing Council decided that we would continue to conduct net asset purchases under the PEPP until at least the end of March 2022 and, in any case, until it judges that the coronavirus crisis phase is over. Our objective is to stimulate the economy enough to end the coronavirus phase.
So let's see what the recovery will look like six or nine months from now, and what happens to inflation and inflation expectations. And let’s remember that, even when the coronavirus phase is over, inflation will still be far from our aim and we will need to use our tools to get back to our 2% goal. In this respect, we have formulated clear forward guidance on how we will use interest rates and asset purchases during and beyond the pandemic period.
Klaas Knot suggested shifting from emergency support to more conventional forms of support. What do you think about this idea?
The decisions to increase or decrease the pace of purchases, and to prolong or end the PEPP, are collegial decisions that depend on the state of the economy. They are conditional on seeing evidence of a robust recovery and sustained inflationary pressures, reflected in an upward trend in underlying inflation, that bring inflation and inflation expectations in line with our aim. From my viewpoint, the conditions that we see today do not justify reducing the pace of purchases, and a discussion about phasing out the PEPP is still clearly premature. Our decisions should not be swayed by narratives from abroad. Instead, they should be guided by compelling data about the euro area.
Should we wait until September or October?
We should wait until we have more clarity on economic and inflationary developments, and until we can be confident that they will enable us to deliver on our mandate. This implies, first, that we neutralise the effects of the pandemic on inflation, and second, that we continue our policy action until we see inflation sustainably reaching levels in line with our aim in the not-too-distant future. In my view, it is reasonable to look at a horizon of around two years for inflation to converge towards our aim.
You will decide in the next few months whether to launch a formal project to assess the possible introduction of a digital euro. But why do you need a digital euro? We already have many tools, such as Visa, Mastercard, Apple Pay, Google Pay…
For two main reasons: we see that people are buying more and more online and that they are using digital payment methods with growing frequency. If these two trends continue, the role of cash as a means of payment may decline significantly. But cash is the payment instrument issued by the central bank, its tangible link to citizens. Providing safe, sovereign money as a public good has been a core mission of central banks for centuries. I think we should continue to fulfil this core mission.
Second, we need to prevent the European retail payments market from being dominated by a handful of non-European players who could be relatively immune from the regulatory scrutiny and oversight of European authorities. This could result in insufficient competition and data protection. And in the absence of a European digital payments solution, our monetary and financial sovereignty would ultimately be at stake.
A digital euro would protect privacy, increase consumer choice, reduce transaction costs and support the digitalisation of the economy while making sure that sovereign money remains at the core of the financial system. And it would level the playing field by allowing all market participants to build on the digital euro to offer additional services.
So do you see the big tech companies from the United States as a threat to Europe?
A small number of non-European companies already dominate some parts of the market for retail payments, such as credit cards and online payments. In the future, the role of the big tech companies could become very significant in financial services, posing risks to privacy, competition and technological autonomy, as we have seen in other markets.
The introduction of a digital euro would help to keep competition open and stimulate innovation while strengthening Europe’s autonomy and financial resilience.
You said that a digital euro would be safe and riskless. But it could also be troublesome. What do you think about the impact on the existing banking system?
The digital euro would offer consumers a safe, riskless, totally liquid means of payment. In the absence of any limits or constraints to its use as an instrument to store wealth, it could attract huge investments, including large transfers of retail deposits from banks to the digital euro. This could increase the risks to financial stability, especially in a crisis.
But we would avoid those risks. There are two possible ways to address them. One is to restrict the holdings of digital euros by individual users, for example to no more than €3,000. This would limit the outflow of deposits from banks to the digital euro. The second possibility is to discourage large holdings of the digital euro by imposing a penalising remuneration on amounts held above a certain threshold.
The digital euro would therefore provide an efficient way to pay digitally in sovereign money rather than act as a form of investment. This would avoid instability in the financial sector and preserve financial intermediation.
Will you restrict using or holding a digital euro outside the euro area?
A digital euro accessible to non-euro area residents would offer a safe means of payment for retail transactions across borders. But in vulnerable emerging market economies, a digital euro could also be a very attractive form of investment. If not properly designed, it could facilitate capital outflows or even currency substitution, which could trigger financial instability. Conditions for access and use by non-euro area residents could therefore be designed to prevent excessively volatile capital flows or exchange rate fluctuations. Limiting or disincentivising excessive digital euro holdings by non-euro area residents are examples of how this could be done.
In any event, international cooperation on design, cross-border use and interoperability would be key to reap the potential benefits of central bank digital currencies for cross-border payments while addressing risks to the international financial system.
China will issue a central bank digital currency by 2022. Would it be a threat to you?
The Chinese authorities have announced that the digital renminbi will be designed for domestic use and for retail transactions. They want to preserve the role of sovereign money in the digital era and they are reacting to the expansion of Chinese big techs.
In the longer term, building interoperability between central bank digital currencies could reinforce their domestic benefits. This would make cross-border payments easier, cheaper and more efficient.
So China is not a competitor, but a partner for you?
Central banks are already cooperating, both bilaterally and in international fora. We are in contact with central banks in Japan, the United States, the United Kingdom, Canada, Sweden, Switzerland and also China. We can learn from each other and improve our understanding of the challenges that are associated with the possible introduction of a digital currency.
When will you start issuing a digital euro?
We started our discussion with the horizon of five years in mind. Five years is likely to be the minimum time necessary for the introduction of a digital euro. The Chinese started working on their digital currency eight years ago, in 2013. The Swedes started to work on the e-krona in 2017, and they have said they might be able to introduce it in 2026. So experience shows that the introduction of a digital currency requires time.
Does that mean we could have a digital euro in 2026?
That would be the earliest date. We should not rush to finish first. This is not a race. We cannot take the risk of introducing a digital currency that will not work well for users, or that would generate instability, domestically or abroad. It is such an important change. If we decide to issue a digital euro, we want to be sure we get it right.