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Interview with Frankfurter Allgemeine Sonntagszeitung

Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Patrick Bernau and Dennis Kremer on 8 July and published on 10 July 2021

8 July 2021

Ms Schnabel, the ECB has set itself a new, higher inflation target of two per cent. Do people now have to fear higher inflation?

No, they don’t. For one thing, the increase in the inflation target is minimal. And for another, a target of two per cent has an important function: it creates space so that our monetary policy can have its stabilising effect. In bad times, such as during the pandemic, monetary policy stimulates the economy through low interest rates and so has significant favourable effects on economic growth and employment. However, today’s interest rates are already so low that they cannot be reduced further very much. That is not primarily the ECB’s doing. We have seen a pronounced desire to save, reflecting demographic developments for example, whereas demand for investments has been comparably low. That is why interest rates worldwide have been falling for many years. The new inflation target safeguards our room to manoeuvre and benefits people.

But if inflation rises too high, it’s not good either.

That’s true. The two per cent target also continues to protect people from perceivable losses of purchasing power.

What would you do if inflation overshoots this target?

Our target is symmetric: inflation may sometimes be slightly above it or below. We look through short-term deviations. By contrast, we regard persistent negative and positive deviations as equally undesirable. But when the economy is close to the lower bound, especially forceful or persistent policy measures are required to safeguard price stability. This may also imply a transitory period in which inflation is moderately above the target of two percent. The Governing Council supported this unanimously.

So Deutsche Bundesbank President Jens Weidmann also gave his agreement.

Unanimous means unanimous.

The inflation rate in Germany will shortly reach four per cent. Might it be that the ECB has already lost control of inflation?

No, this development is temporary. Inflation in Germany is now relatively high on account of the pandemic. We will see this as of July – precisely one year after the reduction in value added tax – when prices will be particularly high compared to last year, but only because prices were reduced at that time. The recovery in oil prices has a similar effect. The Deutsche Bundesbank forecasts that inflation will reach just over four per cent in Germany towards the end of this year, but will already fall again significantly next year. Given such short-term fluctuations, the ECB’s monetary policy is oriented towards medium-term price developments – across the entire euro area. Our medium-term inflation projection is subdued: only 1.4 per cent in 2023. Though that is surrounded by uncertainty, I am sure that we will not experience excessively high inflation.

What makes you so sure?

We are currently experiencing an exceptional situation. First the economy was shut down and then it opened up more rapidly than expected. Demand consequently soared, but it has outpaced supply. Think of the problems with the supply chains.

But what if that continues?

We will watch that very closely. Whether inflation rises sustainably ultimately hinges on whether wages also rise and amplify inflation through second-round effects. So far we have seen little evidence of that – also in Germany.

At what rate of inflation will the ECB start to intervene?

In previous years, inflation was too low. The global financial crisis, the sovereign debt crisis, the pandemic: all these crises weakened demand and dampened inflation. That is why it is important to firmly anchor people’s inflation expectations close to our target of two per cent. Moderately higher inflation is a sign of a better economic outlook. We have to support this with our monetary policy for as long as it takes to achieve our medium-term inflation target.

What happens with countries that have high levels of debt, like Italy, if inflation remains high and you raise interest rates? Will it become difficult for them?

Governments will manage this. Many euro area countries reacted to low interest rates by significantly extending the maturities of their sovereign bonds. An interest rate increase has no direct effect on total sovereign debt, but only on the part that has to be refinanced.

So countries don’t have to worry?

Every euro area country has to be aware that interest rates will not always remain low. That means, above all, one thing: countries must use targeted measures to deploy the large amounts of public money that have, for good reasons, been made available during the pandemic, so that they get to a sustainable growth path. That is the best way to deal with pandemic-induced higher government debt.

In the worst case, the ECB would not risk government default.

We are far away from such a situation, thankfully. During the pandemic, the greatest crisis since the Second World War, there was not a single moment when the debt sustainability of a euro area country was seriously called into question.

The higher inflation target gives you leeway to continue purchasing government bonds for longer.

We are yet to decide on the concrete effects that the new strategy will have on our current monetary policy stance. It is clear that we must achieve our medium-term inflation target in a sustainable manner. Bond purchases are part of our standard toolkit.

You are now describing bond purchases as standard? We learnt something different in college.

That is also an outcome of the strategy review. Our primary instrument is the set of ECB policy rates but, when rates approach the lower bound, instruments such as bond purchases are effective and indispensable.

You haven’t placed the resilience of financial markets in the face of crisis at the centre of your new strategy.

Financial stability actually plays a very important role in our new strategy. It comes into play when we assess the costs and benefits of different measures. In addition, we have modified our analytical framework: as before, we have two strands of analysis but they are now more tightly interwoven. The second strand – previously the monetary pillar – has been expanded with financial considerations and now focuses on monetary transmission and financial stability. Few central banks pay such attention to this topic in their monetary policy.

Climate protection also plays an important role in your new strategy. Why is a central bank involving itself in an issue that is not a monetary policy matter?

Climate protection is first and foremost a matter for governments. But climate change is the greatest risk facing economies in the next decades and it has massive effects on price stability and, consequently, on monetary policy. For instance, climate risks in the financial system can compromise the transmission of monetary policy to the real economy. This means we have to take it into consideration in the context of our price stability mandate. Until now, our models have not sufficiently taken climate risks into account. This is something that we want and need to change.

Are you also going to be looking at whether companies act in an environmentally friendly way?

It will play a role, both in banking supervision and monetary policy. For example, we are planning to only accept bonds as collateral if the companies that issue them disclose climate-related risks. We also know that private sector bonds bought by the ECB are on average relatively carbon-intensive. This is because we buy bonds according to the volumes that are available on the market, and the market is dominated by carbon-intensive companies. But is the market the right benchmark if it fails to take sufficient account of the climate impact? We will be looking into that very closely.

The devil is in the detail. How much agreement is there on that?

We have unanimously agreed on an ambitious action plan. Individual projects will need to be discussed in detail but we all support the overall goal and planned measures.

What if others pipe up now and say: we are also doing great work for society, give us better financing conditions too?

Our overarching goal is price stability. In the case of climate change, the risk of a severe crisis with wide-ranging consequences for price stability is particularly high, and climate change is at least partially irreversible. So it’s problematic for our policy to favour carbon-intensive business activities.

If low-carbon firms were issuing more bonds, you would be buying more of them already.

This is exactly the transition we mean. Once the climate measures fully take effect, market distortions will disappear.

Is it not something that needs to be decided by democratically elected politicians rather than the ECB?

Politicians have already decided just that. But we know that such transition takes time and requires huge private and public investment. The financial market is crucial here. This is where the central bank plays an important catalyst role and can support political efforts.

20 years ago the ECB wouldn’t have discussed such specific issues of economic policy.

Climate change was probably not something that was discussed much even five years ago.

Why has this changed?

A lot has changed in society as a whole. The ECB cannot ignore that. We care about the things that are important to the people – for example house prices, which we will account for better in our inflation measure. We engaged with citizens in our strategy review and we will continue to do so. All of this strengthens people’s trust in their central bank, and trust is valuable in monetary policy.

You want to communicate your monetary policy discussions in “plain language”. Will you manage?

Not everyone will follow our monetary policy statements in great detail. The point is to tailor our communication to different target audiences.

The ECB is getting closer to the public.

That is true, and this could support our price stability objective. While the euro enjoys high approval ratings, trust in the ECB fell somewhat after the financial crisis. It has recovered since but we need to do more. To win their trust, we must ensure our actions are understood by the people.

Is this where Christine Lagarde’s famous charm comes up against the technocratic leviathan that is the central bank?

Christine Lagarde has made a big difference at the ECB. She has put climate change on the agenda. But the ECB is hardly the only central bank that is looking at that topic.

The new strategy was announced sooner than expected – just three short weeks after the Governing Council of the ECB met in the Taunus mountains. Does this suggest that working remotely may not be the answer to everything?

Indeed. Video calls have worked surprisingly well even in serious emergencies. But when trying to reach a consensus, you are much more likely to succeed if you can talk to each other during informal breaks.


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