Interview with Frankfurter Allgemeine Zeitung
Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Gerald Braunberger and Christian Siedenbiedel on 21 February
23 February 2022
Mr Lane, is monetary policy normalisation in the euro area edging closer?
In times of great volatility and uncertainty we should not make absolute statements. But the data clearly suggest that we could be moving closer to our medium-term target.
Has your assessment of the appropriate monetary policy stance changed with recent developments in the Ukraine crisis?
We will conduct a comprehensive assessment of the economic outlook at our March meeting. This includes the recent developments on the geopolitical front. These not only have implications for oil and gas prices, but also for investor confidence, consumer confidence, trade and so on. So in terms of inflation there is not just the mechanical effect from commodity prices, for the medium-term outlook the macroeconomic effects need to be incorporated. As we already flagged at the February meeting, the geopolitical tensions are a very important risk factor right now, for Europe in particular.
So the March meeting of the ECB’s Governing Council could be exciting. What will happen next with the bond purchases and the key policy rates?
It’s important not to anticipate the decision that the ECB’s Governing Council will take in March. A lot can happen before then and, as mentioned, there is much uncertainty in the world. But our strategy is crystal clear: we want inflation to stabilise around two per cent in the medium term. There are three possible ways of getting there. First, if the medium-term inflation outlook falls well below our target, the ECB must pursue accommodative, i.e. loose, monetary policy. Second, if medium-term inflation settles above our target, we would need to tighten monetary policy. Third, if inflation settles around our target in the medium term, then a normalisation of monetary policy, as we call it, would suffice.
What do you see of that right now?
Inflation rates are high at the moment, hitting 5.1 per cent in January. We expect them to decline in the course of this year, but at what pace and by how much is uncertain. The decisive factor for monetary policy is how inflation develops in the medium term. If inflation rates are moving towards our target in the medium term, which is now looking more likely – instead of being well below two per cent as before the pandemic – we will adjust monetary policy, because we would then, for example, no longer need to make asset purchases to stabilise inflation at our target over the medium term. It was different in December, when surveys still showed the expectation that we would need to maintain asset purchases until the middle of next year, but the timeline may be shorter than what people expected then.
Some critics think that the ECB will not dare to end its asset purchases if that would push up the cost of some countries’ sovereign debt and threaten a fragmentation of the bond markets, almost like what happened during the sovereign debt crisis…
Our monetary policy is driven solely by our mandate. If inflation moves close to our target, we will phase out quantitative easing. It’s true that we created a lot of flexibility during the pandemic with our pandemic emergency purchase programme (PEPP). We are also convinced that we need to ensure the transmission of monetary policy works so that our interest rate policy is not undone by fragmentation of the European bond market and the resulting strong divergence in the financing conditions across member countries. In December we said that we will be flexible in our policy when needed. And we also pointed to a particular application of the flexibility: even when the net asset purchases under the PEPP come to an end, we can reinvest the portfolio flexibly. That can help with any fragmentation risk that might arise. But the situation is in any case completely different to that in the financial crisis 13 years ago. The world today is rightly not expecting to see interest rates to return to the levels we saw 15 years ago. Should interest rates move up from a very low level to a slightly higher one, the consequences would not be comparable to what we saw then.
Government spreads have indeed widened slightly in recent months. Up to what point will the ECB accept that?
We make a comprehensive assessment, especially at the quarterly meetings, such as in March. The overall economic situation is that a strong recovery of the European economy is expected. Interest rates have gone up from very low levels but remain low compared to historical averages. Of course, the financing conditions play a role for the recovery. And we will always be vigilant, we care about fragmentation risks.
So where do you see upside risks for inflation?
Following our February meeting we said that, compared with the December meeting, we saw more upside risks. Many of these related mainly to the short-term outlook: energy prices continued to increase and the bottlenecks in supply chains could last longer than expected. But these are not lasting phenomena, they belong to the temporary components of inflation.
But aren’t you worried that almost everyone – central bankers, journalists, economists (with the possible exception of US economist Larry Summers) – has underestimated the degree and persistence of inflation?
Inflation rates are indeed higher than expected, and these will persist for longer than originally thought. That mainly reflects energy prices and the supply bottlenecks, but the longer the origin of the shock remains, the more this affects a wider set of prices. So we are also revising our assessment of the persistence of inflation in this respect. But our instruments take 9, 12 or 18 months to affect the economy; that’s why we emphasise the medium-term nature of monetary policy. Many of the factors that are now driving inflation rates up will play less of a role in 12 or 18 months. The economy is not in an overheating zone. We think that most of this inflation will fade away.
ECB Executive Board Member Isabel Schnabel has also pointed to upside risks for inflation resulting from climate policies. Do you expect “greenflation” to exert extra pressure on prices?
The impact on inflation will of course depend on how the green transition proceeds and this will be a gradual process. A lot also depends on what the countries do with carbon tax revenues. A recycling of tax revenues can boost the economy. At present, however, energy prices are being driven up mainly by global factors, and less by, say, national carbon taxation in Germany.
Investors have been putting less capital into oil companies because they are sceptical about the future of fossil fuels. Does that contribute to the high oil prices?
The huge spike in oil and gas prices is not being driven by the carbon transition. The oil price has essentially been going through a sort of “pandemic cycle”. In the first year of the pandemic, 2020, energy prices fell unusually low. And in the second half of 2021, they recovered strongly. There have been all sorts of supply issues, but these will eventually be resolved. As a central bank, we don’t have to take a stance on exactly where these prices are going. But we need to be agile and responsive to what happens.
If this is all to do with a pandemic cycle, do you think we will go back to the way things were before the crisis – with very low real interest rates, very low economic growth, very low inflation and low productivity growth? Or has the pandemic changed the longer-term inflation trends too?
I don’t think we‘ll go back to the 2019 situation in the coming years. But it is not entirely clear what net impact the changes will have. For example, digitalisation received a boost during the pandemic. This should be an anti-inflationary force as it reduces costs. Business travel being replaced by cheaper video calls is one example of digitalisation. On the other hand, companies that struggled with supply chain problems may become more cautious, potentially focusing on their resilience, their reliability, rather than costs. This could push up prices. In addition, the demographic developments are predictably going to continue, as the population becomes older. There is also the question of whether the internationalisation of the European workforce is coming back. A smaller workforce may translate into higher wages, but also less demand in the economy, so the net impact on inflation is unclear.
Do you really expect trade unions not to try to compensate for the current high inflation rates? Or is it more realistic to expect a wage-price spiral at some point?
We do expect wages to pick up. The question is how much. When we target an inflation rate of two per cent and expect productivity to grow by one per cent, wages in the euro area increasing by an average of three per cent would be consistent with our inflation target. We are monitoring the wage situation very closely. There may be an element of catch-up, but this is not the 1970s – central banks have learnt their lessons. If there was a threat of a wage-price spiral, we would act. And the wage bargaining partners know this, too.
In Germany, many people still believe in the quantity theory: over the years, the ECB has printed so much money that it created inflation, and since it continues to print more money, inflation will continue to grow. Why is this theory wrong?
That is a theory of domestically generated inflation. What we have now, however, is a lot of imported inflation. That theory would also suggest that people have too much money in their bank accounts, leading to a big surge in consumption and investment, which drives prices up. We are not seeing that. It is important to recognise which prices are growing. The most remarkable increases relate to the prices of gas and electricity. Food and other products that need energy as an input are becoming more expensive. But, unlike in the United States, in Europe we are not seeing a general demand boom, just certain catch-up effects related to the pandemic. What we are seeing at the moment is mostly imported inflation, through the prices of oil and gas. The pandemic led to very high demand for liquidity and the ECB had two options: either meet that demand and allow a big expansion in liquidity in the system or have a large increase in capital market interest rates, which would have added a financial problem on top of the pandemic problem.
How is the inflation situation in the United States different to that in Europe?
Both in the United States and in Europe global factors such as the increasing price of oil have a major impact on inflation. However, in the United States domestic factors such as high demand resulting from fiscal measures play a greater role. The stimulus package introduced by President Joe Biden was much bigger than the fiscal stimulus in Europe, with a bigger impact also on the labour market. The inflation rates are correspondingly higher there. This is why we cannot compare the situation of the Federal Reserve to that of the ECB at the moment.
The Fed has already announced its rate hike plans. How could the ECB go about it?
We were crystal clear in our monetary policy strategy, which we published in July. We have a sequencing: our net assets purchases will first be scaled down, then ended. Then, the key policy rates will only increase above their current levels if the conditions consistent with our medium-term inflation target are met. So before we talk about potential rate decisions, we need to end net asset purchases. And we need to prepare the market for the eventual end of these purchases.
How do you personally experience the high inflation rates in your daily life?
Like everyone, we notice that the energy bill has gone up, petrol has become more expensive, the prices for many groceries have increased. But we are of course aware that people with lower incomes are much more affected by the higher prices, and that they also feel the impact of the energy shock very differently.