Interview with Corriere della Sera
Interview with Fabio Panetta, Member of the Executive Board of the ECB, conducted by Federico Fubini
29 July 2021
Now that a strong pick-up is under way, is it right for governments to keep running a deficit to provide an expansionary impetus?
The risks of an incomplete recovery are still high, while the risks of the economy overheating and high inflation are still contained. There is still ample slack in the European economy, with people out of work and production plants that have not reopened. We are still not back to the level of GDP that prevailed before the crisis; we’ll only return to that level in the months between the end of this year and the start of the next year. And we are well below the pre-crisis growth path, namely the point we would have reached if the economy had not been hit by the pandemic. We should recover the GDP lost along the way and the productive capacity and jobs destroyed by the crisis as quickly as possible. The United States is about to reach that goal and I don’t see why Europe can’t do the same. To do this, fiscal policy and monetary policy must continue to support the economy.
Is it possible to do this?
Of course. With additional public investment equal to around 1.6% of GDP, the euro area should be able to return to the pre-crisis growth trend in 2022. If the economy doesn’t grow, the poorest citizens will suffer the most. Europe has new common measures, such as NextGenerationEU (NGEU, the EU’s recovery plan), and we can be ambitious. Only a sustained pace of growth will solve the problems of employment and debt.
It all depends on how the Stability and Growth Pact is revised. Does a system like the recovery fund need to be made permanent?
The European Commission has said that the general escape clause, which allows for temporary deviations from fiscal requirements, will remain in effect until the end of 2022.
Should we make the crisis management system launched in 2020 permanent? I think it would be an important step forward, but not everyone agrees and the different points of view are understandable. Future developments and the possibility of making further progress will depend in a decisive way on how we use the NGEU resources. European funds must be used – particularly by countries benefiting most, like Italy and Spain – to modernise the economy and to trigger a growth phase that everyone can take advantage of.
Even the strongest economies?
Underpinning the approval of the NGEU programme is the understanding that in a single currency area with closely integrated economies it is in the interests of all countries – including those with the strongest economies – to benefit from widespread growth. Anyone who thinks they can grow on their own would be behaving like Baron Munchausen, who wanted to lift himself off the ground by pulling himself up by his hair.
But we can sell to foreign markets. Isn’t China a market for German cars?
Europe is one of the world’s largest economies, we cannot rely on foreign demand alone. During the financial crisis we tried through austerity measures to dampen domestic consumption and have foreign demand as our engine of growth. It didn’t work: we ended up with stagnant demand, a sluggish recovery and a long period of dangerously low inflation.
We need to stimulate domestic demand. The NGEU programme can play a key role in this respect, which will be of benefit to everyone. For example, Germany’s GDP will be higher by half a percentage point thanks to the growth that will be generated in other European countries by NGEU.
What is your opinion of Italy’s recovery fund plan?
In the past, structural reforms in Italy were like the Loch Ness monster: much talked about but seldom seen. But now the situation is different. Unlike what happened during the financial crisis, we aren’t planning reforms during a recession or in the midst of political and social tensions caused by austerity.
The reallocation of resources between sectors and firms is more agile if the economy is growing. The availability of large amounts of funds to be used for reforms and for stimulating growth provides better starting conditions.
Moreover, the basis of the plan presented by Prime Minister Draghi is a very cogent analysis of the problems of the Italian economy: low productivity which translates into low growth, and an unsatisfactory distribution of income and opportunities, including at local level.
Yes, but what about the responses?
Italy’s National Recovery and Resilience Plan (Piano Nazionale di Ripresa e Resilienza – PNRR) has the potential to have a positive influence on the daily lives of households and firms through measures to make the public administration and the judicial system more efficient. Investments are planned in “traditional” sectors (infrastructure, tourism and culture) as well as more innovative areas, such as support to the ecological transition and investment in human capital to overcome the digital divide between Italy and the rest of Europe. With 40% of the funds earmarked for the southern regions, there is an opportunity to address the gap between the south and the central and northern regions – which in my view is one of the main unresolved problems for the Italian economy.
Don’t you think the problem lies in the effectiveness of implementation?
Indeed, maximising the macroeconomic impact will require high quality investments. We are talking about a difference of one point of GDP. The governance of the NGEU programme was designed with this in mind. For example, the gradual disbursement of funds will require the measures to be implemented in line with the provisions of the PNRR.
And I think it goes without saying that Prime Minister Draghi is very well aware of the importance of making the best use of every euro out of the €200 billion that will be made available.
But will the Italian economy grow after the initial rebound?
It is growing and the stimulus from the NGEU is now on the way. The Italian economy will also benefit from the indirect effects of the stimulus that NGEU will provide to the other EU economies.
It is one thing to rebound by 5% after a slump, but quite another to continue at the same pace. Can Italy do it?
If the reforms provided for in the PNRR succeed in modernising the Italian economy, increasing its growth potential, in the coming years a fast pace of growth will be possible. There is the fiscal stimulus making the economy expand and then there is the effect of the structural reforms.
Governments always say that they are combatting tax evasion and carrying out reforms. Then they cut investment.
The funds to carry out investments are now available alongside a coherent plan for reforms. And all this will be set in the context of a growing European economy. Therefore, robust growth rates are not impossible.
The ECB has just approved its monetary policy strategy. Some claim it is more restrictive than that of the Federal Reserve System. Is that true?
We have clarified that we want an inflation rate in the medium term of 2%, not below 2%. A rate of inflation of 1.4% or 1.5% – like we currently have in our projections – is unsatisfactory. We have also clarified that a 2% rate of inflation is not an ultimate limit: if it helps to anchor expectations and makes the 2% target credible, then we can temporarily go slightly above it. Because inflation has been below 2% for so long, we need values of above 2% to pursue our target symmetrically.
These seem like subtleties for insiders…
They aren’t, though. A too-low inflation target can put excessive downward pressure on interest rates and hinder central bank efforts to support the economy. This can be very costly in terms of growth and employment.
The new formulation in the strategy should remove the misconceptions generated by the previous definition of inflation as “below, but close to, 2%”, which led people to believe that the ECB wanted to stay well below 2% and that it was ready to intervene as soon as there was a risk that price dynamics might overshoot that threshold.
What exactly does all of this mean for your monetary policy?
Above all, we will respond forcefully to negative shocks that can push inflation below our target. For cinema-lovers, from now on when inflation falls below 2% our monetary policy should take inspiration from “Pirates of the Caribbean”, even if some would prefer “Sleeping Beauty”.
When price dynamics approach 2% we’ll be patient, however: we will only raise rates when we’re convinced that inflation can be firmly anchored at 2% in the medium term according to a series of parameters which are clearly set out in the new forward guidance, for both expected and actual inflation.
Can you explain why the way in which your stance on inflation is perceived as so important?
The ECB is a very important institution in terms of the economy’s development, and particularly for the path of inflation. If the ECB lets it be known that it is willing to accept very low inflation, then market participants will take this into account. Unions will take it into account during wage bargaining. Firms will take it into account when pricing their products.
The ECB’s inflation target influences inflation expectations and, as a result, actual inflation. Its definition must therefore be clear and credible if our monetary policy is to be effective.
Do the choices made as part of the strategy reflect the fact that the Delta variant is giving cause for concern?
The strategy review established the “ground rules” of monetary policy which will be valid for everyone in the coming years. The forward guidance renders these rules operational and indicates how we will react if the Delta variant delays the return of inflation to 2%. But it’s not a response to the variant.
But could the Delta variant hinder the recovery?
I’m not an epidemiologist and I can’t foresee what will happen with the virus. Some European countries have reintroduced social distancing measures, and we can’t rule out the possibility that this may end up stymying the recovery. The impact will probably be weaker than it was for previous waves. This is partly because many people have been vaccinated, partly because we are learning how to protect ourselves.
Having said that, the still challenging situation in emerging economies also poses risks for us.
Does being prepared to tolerate slightly higher inflation also imply that you would be prepared to accept an overheating economy?
In the past, impatience led the ECB to raise rates prematurely, keeping excessive downward pressure on inflation and stymying growth. So it’s therefore clear to everyone that in order to guarantee price stability, it may be necessary to, as they say, “run the economy hot”, to let it rev up a little.
Isn’t that risky?
On the contrary. It’s a way of making our efforts to bring inflation up to 2% credible. It’s a prerequisite for making full use of the labour resources available and for generating upward pressure on wages that will push inflation up to levels in line with our target.
Is it not the case that after the summer, you will show a more hawkish side by reducing the pandemic emergency purchase programme (PEPP), the bank’s special asset purchase programme?
The Governing Council has not discussed this issue. It is no secret that there are different opinions on this topic, and when a discussion starts from very different points of view, it’s best to deal with and solve one issue at a time. So the discussion on asset purchase programmes is yet to take place. I can give you my opinion on the matter...
At the moment the ECB is using two monetary policy instruments in particular: the recently approved forward guidance on interest rates, and asset purchases. It would not make sense to implement an expansionary monetary policy with one instrument (forward guidance) and a restrictive monetary policy with the other (asset purchases). The main issue for me is how to use asset purchases effectively to consolidate the forward guidance, in particular to ensure an even transmission of monetary policy throughout the euro area.
What makes you think that the increase in inflation won’t last?
Inflation has risen because oil prices have been rising, but they can’t rise indefinitely. Bottlenecks in production have also pushed the prices of certain goods up for a few months, until the economy returns to normal. There has also been a temporary boost owing to the recent increase in VAT in Germany following last year’s cut. These are all transitory factors that will only have a temporary impact on inflation.
Central banks in the United States and the euro area have been working with governments to support the economy. Some think this could damage the central banks’ independence. Do you agree with this?
Consistency between monetary policy and fiscal policy is crucial at the moment: with negative interest rates, low inflation and weak demand, monetary and fiscal policy both have the objective of getting the economy operating at full capacity again. During the pandemic households and firms were paralysed by lockdowns and uncertainty about the future, and everyone agreed that central banks and governments should push in the same direction. Consistent monetary and fiscal measures are still needed to stabilise inflation at 2%. Our forward guidance shows how financial conditions will develop in the future, allowing governments to take measures without being afraid that the cost of debt will rise prematurely.
There are some who fear that this will result in fiscal dominance – when central banking is subservient to governments’ objectives.
When it’s necessary to take fiscal measures to safeguard price stability, if monetary policy allows fiscal policy to operate this does not result in fiscal dominance. On the contrary, this would be monetary dominance, in that the central bank would actually be using fiscal policy to achieve its inflation target.
How would you explain to a lay person that the digital euro will improve their life?
Today European citizens are making ever more payments using private digital means – think of credit cards – and are buying ever more products online. These trends limit the ability to use banknotes, which offer everyone the option to make risk-free, costless payments. The digital euro will complement cash, offering the option also in the future, in a digital era, to use a universally accepted, risk-free and costless means of payment. No one will be left on the sidelines of payment facilities. Having the digital euro will be like having cash, but in digital form.
Are you taking action because you are afraid that the Chinese digital currency or the Diem – Facebook’s currency – will take over the European market?
That’s not the main reason. If citizens want to make digital payments or make purchases online, the State – more specifically the central bank – must provide the payment instruments to do so. Moreover, the currency is a symbol of the strength, stability and reliability of the State. A State without a currency would be unthinkable, it would only be half a sovereign. For this reason, in a world that is becoming digital, the European Central Bank is assessing the possibility of developing its own digital means of payment alongside cash.
That said, we are not unaware that China and Facebook are working to issue electronic means of payment. A digital euro would protect European monetary sovereignty. But I don’t believe that the euro area is particularly vulnerable to the spread of a Chinese digital currency or the use of a private digital payment instrument. And there is no need for so-called stablecoins, which are instruments that are stable in name only.
Why might they not be stable?
Because they cannot guarantee 100% of the value of the instruments they issue. And we cannot offer citizens a payment instrument that could be worth less at face value tomorrow than it is today. By contrast, the central bank can guarantee 100% of the nominal value of the means of payment that it issues. Commercial banks can do this too thanks to a series of safeguards provided by law: supervision, deposit guarantees and capital requirements.
Proper regulation is required to make stablecoins truly stable. The measures being taken by the European Commission (with the Regulation on markets in crypto-assets) and the Eurosystem (with the launch of the system for supervising electronic means of payment) are going in the right direction and positioning Europe at the cutting edge. But the risks for citizens are still fairly high.
Diem is prepared to let the ECB and the Federal Reserve System distribute their digital currencies via its infrastructure.
This is the opposite of the line from “The Godfather”: it’s an offer that can’t be accepted. It is an ideal offer for Facebook, not for the European economy. We cannot put the entire payment system – which must allow citizens to do their daily shopping, to receive salaries and pensions, and to access their savings – into the hands of a private monopoly. These are tasks and functions that the central bank cannot relinquish. Only the central bank can offer these services with the sole aim of guaranteeing the common good.