Interview with Financial Times
Interview with Christine Lagarde, President of the ECB, conducted by Martin Arnold on 11 July 2021
13 July 2021
It is only a few days since you announced a new strategy. How will this change the ECB?
I think what has changed is how we define price stability and while in the past, we had this vaguely ambiguous and a little bit complex “below, but close to, two per cent”, we now have what I would call a simple, solid, symmetric two per cent target. So we express very firmly that we are determined to deliver two per cent. I think that is a big change.
Number one, it is simple. So we do away with the perceptions, the ambiguity, the variations between what some see as 1.7, others as 1.95. It's two per cent and it is simple. It is solid because it gives us space to manoeuvre our monetary policy, it is a well-accepted measurement of price stability around the world and it limits the welfare cost of too high inflation.
And maybe the really important third “s” is symmetry, because we affirm very clearly that there may be deviations up or down, either below or above two per cent and we state that we consider both deviations up or down as equally undesirable. At the same time, we know that it's not going to be a straight two per cent linearly forever once we reach the target and we'll recognise that it will oscillate around two per cent.
And finally, we also acknowledge and draw the conclusion from the constraints resulting from the effective lower bound, and we know that as we are close to the effective lower bound, it will require an especially forceful or persistent monetary policy response. So those two qualifiers are very important: an especially forceful reaction or a persistent reaction because we are close to the effective lower bound.
So that's what has changed from a pure monetary policy point of view. I have also some other changes on my mind. And you can obviously understand that having inserted climate change as one of the key components that we take into account going forward is important, is important to us all, because it was unanimously agreed. But it was important to me as one of the goals I had.
It has been an 18-month process and you have done a lot of work and heard from a lot of people. What are the main lessons you've drawn from the strategy review?
There are two lessons that I draw from that process. One is that process matters. And bringing together staff from the entire euro system was important, taking time and making sure that we actually spent a full day, sometimes more, with all Governing Council members able to respond, to react, to internalise, to convince all other members of their views and to arrive at some collective thinking. In my view, this was decisive in making sure that we had turned every stone − as I had committed to at the beginning − and that all voices were heard.
Second, we made a point of listening to the people, which I don't think had ever happened before. So throughout Europe, in 19 countries, and certainly at the ECB, we conducted what we called − copycatting the Fed a little − the ECB Listens. There were multiple events that took place in various countries. I know that, France, for instance, has had 19 different events, not only to listen to what people thought, to hear their concerns, but also to try to explain what monetary policy was doing and what contribution it made to the economy, to investment, to employment with the overarching goal of price stability. So that was a real learning experience for all of us, I think, to understand the Europeans’ concern about monetary policy, what it does, what inflation means to them, what links there are with unemployment, which was a big concern.
What were their biggest concerns?
During the events that I participated in myself, and I heard it from other governors, key concerns revolved around, number one, climate change. Why aren't you doing more about climate change? Why are you financing some segments of the corporate sector that are not respecting the commitments of the Paris accord or that have no concern for the planet? That we heard loud and clear. The second concern that we heard loud and clear as well, was housing costs. Housing costs us a lot, we Europeans, and this was the case in many countries. Why is it not more taken into account in your measurement of inflation? And that led us to do two things. One is to identify a technical and statistical path to better including housing costs in the Harmonised Index of Consumer Prices (HICP), which is not something that we are responsible for, but that we can recommend and encourage, which is what we've done. It would be for Eurostat to hopefully deliver. But second, because we know it's going to take time, we also agreed to take into account alternative measurements, alternative indexes that are not necessarily published in the same rhythm and in the same sequences as HICP, but which will also inform our decision-making process. Those are the two major, strong inputs that we received from the ECB Listens events.
By ditching the inflation target of below two per cent and diluting the importance of its monetary analysis, are you breaking the final links to the old Bundesbank strategy that shaped the creation of the euro?
No, I think what we tried to do with the strategy review was to really adapt the ECB to a world that had changed significantly in the last 20 years. The strategy review was not a random or tantrum decision on my part. It was the acknowledgement that since 2003, the world had changed a lot. You know, the natural interest rate, the equilibrium rate had gone down. A lot of factors were having an impact that probably was not as strong in 2003, let alone in 1999 when the euro was launched. So demographics took not a new turn - because it's a long trend - but certainly became more salient. Productivity was clearly affected as a result of the various crises and the saving trend and behaviour - all that has changed since 2003. And it required that we had a fresh look at the strategy of the central bank to make it fit for purpose for the current circumstances. And I think it's also a recognition that circumstances will continue to change, possibly at an accelerated pace because of the digital revolutions that will be accelerated because of the greening of our economies that need to take place. It's in recognition of that, that we agreed that the strategy would have to be looked at again and reassessed in 2025.
Does the new strategy make the ECB more accommodative than it was previously?
I think the new strategy gives us the ability to be flexible around two per cent, because we recognise that two per cent is not a ceiling and we recognise that there will be oscillation around two per cent. It is more flexible in that we recognise the effect of the effective lower bound and the constraints that it imposes on us. And we define very clearly with the especially forceful or persistent response and the strong response that we are prepared to give. And we also accept that it may imply on a transitory basis, moderate deviations above the target. So in that sense, it is more flexible.
Second, we also recognise the effectiveness of all the tools that we have in the toolbox. And that is not just the first and foremost and traditional tool of the ECB interest rates. But we recognise the effectiveness of those other tools that we had to invent over the course of the last ten years, which are forward guidance, asset purchase programmes, targeted longer-term refinancing operations and negative interest rates. So in that way, I'm not saying that it is more accommodative, but I'm saying that the tools are there and, if they need to be used, we recognise their effectiveness and the fact that some of them, given the effective low bound that we are close to, will have to continue being used.
Do you think the new two per cent target and the acceptance of some overshooting of it in certain circumstances mean that you will be more patient before raising rates in the future, even when you hit your inflation target in the medium term?
I think that what we will have to do now is redefine our forward guidance to align it with the strategy review. When we say that our response has to be especially forceful or persistent, I think persistent is precisely intended to signal that we will not prematurely tighten. But that will have to be a little bit clarified in the forward guidance that we will revise shortly in order to align it with the strategy review. But the use of “persistent” is an indication that there cannot be premature monetary tightening as we have seen it in the past.
That word “persistent” does seem to be key. So do you think it will feature in your forward guidance?
The forward guidance will have to align with the strategy, as we have agreed upon. I'm sure that we will try to shed some light while reserving enough judgement, discretion and capacity to adapt to circumstances. But I don't want to prejudge on that because that's going to be debated around 21 and 22 July.
Critics say that the new strategy has done nothing to convince them you're better equipped to hit your new target more than you have done in the past. Why should they believe you this time?
Three points. One is we will remove any ambiguity. Below, but close to, two per cent is ambiguous. You can sit down on either side of 1.8 or 1.7 or 1.9. And those decimals actually matter. So we remove the ambiguity. It's two per cent full stop. Second, I think our commitment is strongly affirmed. We are committed to delivering on our target, which is two per cent. The strategy, which I regard as a sort of constitutional foundational framework chart for future monetary policy determination, is a strong signal. We are all on the same page. There's a unanimous agreement. There is a total consensus around that foundational document, that constitution of ours. And third, there is also a commitment to better communicate around the strategy review, which I hope we are doing, but also to better communicate on an ongoing basis so that the ambiguity that we have removed from the “below, but close to” does not resurface with ambiguous communication. So I think that, of course, proof of the pudding will be in the eating, but we need to be very clear in our communication of our commitment to deliver our 2 per cent target
The first test will be in changing your forward guidance in just over a week and a half.
It will be tested every six weeks from now on. But I'm not under the illusion that every six weeks we will have unanimous consent and universal acceptance because there will be some variations, some slightly different positioning. And that is fine.
The ECB said in its strategy review that it discussed new instruments. Did you discuss things like buying other types of assets, like equities and bank bonds, or even doing direct distributions of cash like helicopter money?
As I said, we tried to leave no stone unturned, so out of intellectual integrity, we looked at the whole range of anything that you can think of. But that was as part of the intellectual exercise of looking at the whole realm of possibilities. But it didn't go further than that.
Did you reach any conclusions on the possibility of those being in your tool box at a future date?
We certainly concluded that all the unconventional and new instruments were actually part of the toolbox and could be used under the circumstances of the effective lower bound and the need to be persistent in our response.
Did you assess as part of the review whether further loosening of monetary policy is less effective when interest rates are already at or close to their effective lower bound? What was your conclusion?
What we reaffirmed very clearly is the principle of proportionality, of measuring the efficiency, the effectiveness, of calculating the possible side effects and doing what I call a cost-benefit analysis. We are committed to doing it each and every time, as we should. And that was the high-level strategy platform that we agreed on. It's then a monetary policy decision, a mechanism to actually apply that reasoning to each and every tool that we possibly recalibrate one way or the other.
People have said your new strategy doesn’t mention the elephant in the room, which is fiscal policy. Why not come out and say that to hit your inflation target you need more help from fiscal policy, for instance, a permanent borrowing facility at the EU level and more flexible fiscal rules at the EU?
It is actually extensively mentioned, but not in the two-pager. In the 15-page accompanying document, you have quite a bit on fiscal policy and on the close bond between fiscal policy and monetary policy. And, yes, you're completely right that in this environment of low interest rates and when there is the slack that we still have, fiscal policies are very effective and fiscal multipliers are higher and both of them working in tandem is actually much more efficient. So it is not that we were completely oblivious to the fiscal policy impact. Quite the contrary, we did actually have one special seminar on fiscal and monetary policy and there is a lot of hard work that was put into it.
A big worry for some Governing Council members is monetary financing and the idea that you will end up being unable to tighten policy when needed, even under your new strategy, because it would be too painful for the heavily indebted countries of southern Europe in particular. Did you examine this potential problem in the review?
This is a matter that was obviously raised and discussed when we looked at fiscal and monetary policy and how one actually multiplies or leverages the other, and how different it has been this time around from the great financial crisis and the immediate years after that. I think there are sufficient safeguards both on the monetary front and on the fiscal front and obviously, they're going to return and come back into the debate on the fiscal front in particular. But as far as monetary policy is concerned, we have a clear and unambiguous prohibition to do monetary financing. And we have to absolutely respect that, whatever format, whatever clothes it takes. Equally, on the fiscal front, there are many safeguards that have been put in place that have been escaped from over the last couple of years and will continue to be escaped from until the end of 2022, but will come back in some shape or form in order to protect from this monetary financing.
Do you have a view on the shape of the EU fiscal rules when they are reintroduced? This debate has already started in Brussels. Do you want to contribute?
If we are asked for our views, we will certainly communicate them. And I think we have in the past already. But we are certainly keen that whatever is built is simple, easy to measure, countercyclical and comes soon enough so that governments and investors actually know where they stand in terms of the framework within which fiscal policies will be exercised. I think we've also been known to argue that a good euro area budget is certainly a step in the right direction in order to complete the monetary union by giving it a fiscal arm as well. But this is not really a decision that belongs to central banks. It is something that is going to belong to the governments of the 19 Member States.
Your new strategy includes “the recognition that financial stability is a precondition for price stability”. Does that mean that if we have another shock in the future and spreads widened dramatically in government debt markets, we could count on the ECB to do whatever it takes to combat that.
We have demonstrated that in the past, and we certainly fought against the risk of fragmentation simply because we want our monetary policy to be properly transmitted throughout the entire euro area. So if that was to happen again, we would certainly take the measures in order to protect the transmission of our monetary policy and set aside that risk of fragmentation. In the words of one of my predecessors, the euro is irrevocable and monetary policy has to be channelled through all corners of the euro area.
What is the goal of your climate action plan? Is it to guard against the risks of climate change for the ECB's own balance sheet and the wider financial system? Or do you have broader ambitions to act as a catalyst for making Europe a greener place?
Both. It's clear that, from a risk management point of view, we just have to change the way in which we operate by better analysing, better advising and being active in relation to our own portfolio and our own eligibility criteria when it comes to accepting collateral. So it's on all three fronts. The analytical work that we do has to factor in climate change in a much deeper and better way. The advice that we give, in particular through ECB Banking Supervision, has to embed climate change concerns and alert the banks with which we work to the risks that they are facing. And we've very recently done a lot of climate change testing and scenario analysis using the Network for Greening the Financial System scenarios to really understand, and help the banks understand, where there is exposure and how concentrated it is. And we have to act. We started on our non-monetary policy portfolio. We are going to extend that.
We are not going to invent the information and disclosure requirements. We are not going to be able to actually assess the transition plans. And there will be lots of efforts that will be required by the standard setters, by the auditors, by the accounting firms and all the rest of it. But we also have to be, together with these others, at the forefront and not three steps behind. And if we signal that strongly enough, then we certainly operate as a catalyst force. When you set eligibility criteria, it's a bit of a signal.
There are growing tensions in the Governing Council, particularly over the pace of your emergency bond purchases. How long can you preserve this unity that you have managed to construct, not least by sitting down with all your fellow Governing Council members to watch the football and by going on retreats to the Taunus hills?
I neither have the expectation nor the illusion that we will be unanimous on all the decisions that we make. As I said, I regard the strategy review as foundational. The agreed framework within which we are going to weave our policy responses over the course of the next five years, and that's why it mattered so much to me. That's why we went to the Taunus retreat and spent two days hammering out some of those issues and why we watched football together. Yes, that's true. But the weaving of monetary policy within that framework is going to take multiple colours. So unanimous agreement on each and every weaving moment is not a requirement. The more we can agree, the broader the agreement, the better. I think we should really not undermine or underrate those keywords that we have, which is this especially forceful or persistent reaction, the recognition of the constraint, this sort of gravitational force exercised by the effective lower bound that we have to resist, and the transitory period during which we recognise that our policies may imply a moderate deviation above target.
On those keywords, how key is the word “or”? Why not say especially forceful “and” persistent monetary policy action?
I think it's the recognition of the effective lower bound. The “especially forceful” is if the economy is facing an adverse shock. So in the face of the adverse shock, you have this especially forceful reaction because you don't want to be trapped. But recognising that close to the effective lower bound you need to be even longer in the game, that's why you say “persistent”.
Do you think that you are already forceful enough because you're clearly close to the lower bound? Or is it now just a question of being persistent and you’ll get there?
It’s being persistent. It's being very attentive to the next projection and how both headline, core and other indicators of inflation and inflation expectations will be delivering, to see that the persistence we have demonstrated is actually moving the needle.
The new strategy says you will “continue to respond flexibly to new challenges as they arise”. Does this mean that you want to preserve some of the added flexibility of the PEPP, your pandemic emergency purchase programme, after it ends, for instance, on issuer limits and also on buying non-investment grade securities like Greek bonds?
This is not something that we debated as part of the strategy review. We will discuss those matters because they will matter when we get closer to the end of PEPP, but this has not been a strategy review topic.
We've seen record rises in house prices in many European countries and many countries in the world. At what point could the risk of a housing bubble and bubbles in other asset markets lead to changes in monetary policy?
It really depends on what we see. And while there are cities, in particular in some countries where housing prices have gone up significantly and are a concern for people, we don't see it on average across the euro area. We will include housing prices through alternative indexes into our assessment of overall inflation.
The cost of owning a house, not house prices, right?
We will include the consumption part of owning a house. So we will not include the investment part.
There is still much to be decided on how you implement the strategy isn’t there?
Sure, and it will be a constant effort every six weeks. But I tell you, it's been a very interesting process, sometimes laborious, but every bit of it was helpful and conducive to this result.