Interview with Handelsblatt
Interview with Luis de Guindos, Vice-President of the ECB, conducted by Frank Wiebe and Jan Mallien
29 July 2021
Mr De Guindos, the European banks’ stress test results will be announced on Friday evening. What can we expect?
We are not publishing any details until Friday evening, but I can already tell you this much: European banks are robust, they are resilient. The adverse scenario is even more challenging this time than it was in the last test held in 2018 and, on top of that, banks have just come through the difficult year of 2020. Despite this demanding framework, banks have generally performed well in the test.
The average is one thing, the distribution another. Were there significant outliers?
You are right. The range was probably not any wider than last time. But we must of course keep a particularly close eye on banks with clearly below-average results.
Let’s stay on the topic of financial stability. We now have years of lower interest rates and continually rising stock prices behind us. In the United States especially, people are voicing concerns that the system’s debt levels are increasing. How worried are you that maintaining a loose monetary policy will generate bubbles which ultimately imperil stability?
In the euro area we have a lower level of private indebtedness of the economy than in the United States. Some smaller segments of the residential real estate sector may be at risk of overheating, but that was also the case before the coronavirus (COVID-19) pandemic. And, importantly: the greatest threat to banks, namely a surge in insolvencies and defaults, has not materialised so far despite the fears we had at the start of the pandemic.
But in general, isn’t there still the danger that a prolonged loose monetary policy will create risks? How can you keep those risks under control?
In formulating our new strategy we decided on a reform, which I don’t think has received enough attention. The previous two pillars of monetary policy, the economic and the monetary analysis, are now being integrated. Monetary policy decisions are built on an assessment of the economic analysis and the monetary and financial analysis, the latter explicitly including financing stability considerations. That is a major step. Moreover, our stimulating monetary policy is necessary now − and for the time being in order to maintain favourable financing conditions.
Does that mean that financial stability will play a more prominent role in future than it has up to now?
Yes, that’s exactly what it means.
There are fears that the European Central Bank (ECB) will never manage to normalise its monetary policy, because higher interest rates would be too risky, especially for highly indebted countries.
The normalisation of monetary policy, and equally of fiscal policy, follows the normalisation of the economy. If the recovery takes hold, if we go back to pre-pandemic output level, growth is back to potential and inflation reaches our target of 2 per cent, then we should start to normalise our monetary policy. We need to fulfil our price stability mandate, under all circumstances.
But there is still a mountain of sovereign debt.
Yes, that is a legacy from the pandemic. All in all, public indebtedness will be about 20 percentage points higher than before the pandemic. And it’s crystal clear: countries with especially high levels of debt must find a credible path back to sound finances, albeit cautiously and not prematurely. The markets will demand that. But it’s also obvious that the countries had to take action in the crisis in order to contain the economic fallout of the pandemic.
Many economists think that the old rules under the Treaty of Maastricht, of a budget deficit of no more than 3 per cent and government debt capped at 60 per cent, both relative to GDP, have long become outdated because of the current low rates of interest.
Whatever the exact rules are, it’s more important that countries reduce their public debt ratio. But that should only be done when this crisis has faded away.
Do we need a central fiscal authority at European level, also to give the ECB a common counterpart for its monetary policy instead of 19 different governments?
Yes. We need a central fiscal capacity at European level, which would become a key component for the completion of the economic and monetary union. But that would indeed require fiscal and financial convergence among the individual euro area countries.
To that end, would it be helpful if inflation in Germany continued to slightly exceed that in weaker euro area countries?
That is exactly what we have been seeing, for example, in comparison with Spain since 2011. And this has been reflected in the Spanish current account surplus since 2013 until today.
During the pandemic, but also throughout the preceding long phase of low inflation, a certain degree of coordination between monetary policy and fiscal policy was important. In this instance, both have been working towards the same goal. But what if differences emerge between the two later, when inflation picks up?
Without this joint effort of monetary and fiscal policy, we would be in a much worse place today in terms of inflation, growth, and employment.
Let’s get down to the details of the monetary policy stance. In its July meeting, the ECB adopted a somewhat complex formula determining when interest rates may increase. Some observers have offered a simple summary, which reads: lower for longer. Is this the correct interpretation?
We agreed, with a large majority, to increase interest rates when we see inflation reaching our 2 per cent target well ahead of the end of our projection horizon and durably at least for the rest of the projection horizon, which presently stretches until 2023. We also need to see a realised progress in underlying inflation. This is not the case right now. While we are currently seeing inflation rates of close to 2 per cent in the euro area, we are expecting them to fall next year and remain in those levels after.
What do you base that assessment on?
We draw on a number of different indicators. But the core components are the official ECB staff projections and, especially, the assessment made by the Governing Council of the ECB.
Short-term interest rates are just as important as the ECB’s asset purchase programmes. The pandemic emergency purchase programme (PEPP) with a total volume of €1.85 trillion is due to expire at the end of March 2022 at the earliest. When will we find out whether it will really end then?
We still have time to decide about the future of PEPP. In September we will set the pace of the purchases for the fourth quarter, in December for the first quarter of 2022.
What will the decision depend on?
The PEPP should end when the emergency is over and its dampening effect on inflation disappears.
How do you define the end of the emergency?
It is a medical question first and foremost. It depends on whether the vaccination campaigns are successful in combating the delta variant and whether new, more resistant variants appear.
When will the economy go back to normal?
Some define it as being back to pre-pandemic levels. I would argue that back to normal means back to the pre-pandemic growth path.
Could we see the asset purchase programme (APP), currently running at a rate of €20 billion net purchases per month, increase when the PEPP ends post-March?
There are a number of options. In my view, the main priority is to avoid a cliff effect when the PEPP expires. We will need substantial monetary support for the economy for some time to come. Even if recovery is successful, there is still a lot of uncertainty.
The PEPP is more flexible than the APP. The PEPP allows targeted bond purchases from specific countries, regardless of the capital key, which is weighted by economic output and population. Would it make sense to transfer that flexibility to the APP?
We deviated from the capital key somewhat at the beginning of the pandemic, which was certainly helpful. But since then, the bond purchases have broadly been in line with the weights of the capital key.
Do you think there will be more tension within the Governing Council when it meets to discuss these topics in the autumn?
The Governing Council is made up of 25 knowledgeable people and I respect the differences of opinion that may transpire.
Let’s focus on the core of monetary policy – inflation. In the United States in particular a lively debate is under way about whether the current pickup in inflation is temporary or a sign of more lasting price increases. What is your opinion?
Our situation is very different to that in the United States. Over there the inflation rate is well above 5 per cent. For the euro area we are expecting a peak around 3 per cent in November. Next year the pace of inflation will slow down again when a number of one-off effects, such as the temporary VAT cut in Germany in 2020, disappear.
What happens if people get used to higher inflation and react accordingly?
The potential second-round effects such as increased pressure on wage bargaining behaviour or indexation of pensions and the salary of civil servants is something we need to monitor closely. This is because temporary inflation must not be allowed to become structural inflation. So far, however, there have been no indications that this is the case, but we should remain vigilant.
Let’s go back to financial stability. How worried are you about cryptocurrencies such as bitcoin?
First of all, I would call them crypto-assets, not cryptocurrencies. So far, we have not seen evidence that they threaten the stability of the system, but this may of course change in the future. We need to continue reminding people that these are highly speculative investments whose valuations are based on extremely weak fundamentals.
Is bitcoin the motivation behind the creation of a digital euro?
This is a completely different subject – a digital euro will complement banknotes. And we must keep financial stability considerations in mind. A digital euro will complement cash and services offered by banks. People will be given new opportunities to access the digital world.