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Interview with Politico

Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Johanna Treeck and Suzanne Lynch on 28 March

29 March 2022

What are your views on the inflationary outlook? It is obviously an issue that is affecting citizens, people all over the European, eurozone economy. Where do you read things at the moment?

If you go back to last summer, we would have had the view that inflation was still essentially subdued, and that we were basically in a campaign to bring inflation gradually to the 2 per cent target. And remember, we published our strategy review last July, and so on. Then, what we’ve seen in the last number of months is the energy shock, which is by far the dominant factor and which is now further amplified by the war. This is quite sudden. People were not expecting this, governments were not expecting this, households and firms were not expecting this. For that reason, right now, clearly inflation is a huge issue across Europe, absolutely. And how to respond to this, the implications for fiscal policy, the implications for wage negotiations, the implications for demand and so on – this is a very important issue right now. But this relates to a second issue, which – for us and for everyone – is how long will this episode be? This is where we would still diagnose that this essentially is an imported inflation shock, it’s a supply shock. And for these reasons we would still maintain – by the way, I don’t think it’s unique to the ECB, it’s the general economics profession – that most of this inflation will fade away. Fading away from inflation doesn’t mean that these high prices will reverse. Europe may have to get used to higher prices. But the momentum – where every month you wake up and you read that inflation is higher than the previous month – that element, the momentum element, we do think will decline. We do think that inflation will decline later this year and will be a lot lower next year and the year after compared to this year.

This is the kind of nuanced issue. The current episode is extremely serious, requires a lot of change in behaviour, but at the same time – going back to the very popular analogy of the 1970s – we don’t see this as a kind of locked-in phase where every year inflation will be high. We do think, because it’s imported inflation, that essentially the momentum will level off.

You mentioned it’s not an ECB-specific phenomenon, but there have been other attitudes or actions taken by other central banks. How do you explain the ECB’s strategy on this?

It essentially boils down to the diagnosis that the balance between imported inflation and domestically driven inflation is different here. Remember, compared to the United States, first of all, Europe is a major energy importer. The United States is an energy producer as well as an energy user. So, for the United States, high oil prices will benefit some parts of the US economy, because of the oil producers. Whereas for Europe, because more than 90 per cent of energy is imported, it’s essentially collectively bad news for Europe. So, number one is that the energy shock is more significant for Europe. And number two is that we don’t have the same domestic demand conditions. For example, the scale of the fiscal policy injection last year was much bigger in the United States than in Europe, and so the ingredients for domestic inflation are simply weaker in the euro area than they are in the United States.

To what extent do you share the view that the projections are already obsolete, both on growth and inflation, as some of your colleagues have suggested?

There are mixed signals coming through. The higher energy price is definitely above the baseline, that’s for sure. We also have quite significant and substantial drops in sentiment indices, both for consumers and for firms, which of course is a major concern. But so far we are not seeing the kind of very non-linear disruption in the supply of energy. We’re not seeing a scenario so far where not only is the price of energy fairly high, but the supply also becomes unavailable to Europe, which would be much more of an interruption to economic activity. This permeates our assessment. We also see a reopening of the European economy after the latest coronavirus (COVID-19) wave. So, if I put all that together, it basically says that some indices are showing upside concern for energy prices and other indices are showing downside concern for activity levels through the sentiment channel. Rather than making an assessment on a day-by-day basis, we’ll be closely monitoring the balance of these factors.

How would that balance have to change for you to continue asset purchases beyond the third quarter?

It revolves around the medium-term inflation, since that’s the key orientation for monetary policy. Let me decompose that. We have two forces. One is high current inflation, which runs the risk of creating its own momentum through second-round effects. On the other hand, if we see a significant downward revision in demand, that on its own terms will imply a downward revision for medium-term inflation. So, it’s essentially about quantifying the relative strength of those forces.

Given that current forecasts are already close to your 2 per cent target, would a limited shift in the outlook prompt a quicker exit?

What we said is that it is basically too early to know what the correct calibration of asset purchases is for the third quarter. In March we had an inflation outlook which was getting close to 2 per cent. If that outlook is maintained, we will be looking to end net purchases in the third quarter. If it weakens, or if financing conditions deteriorate, that would be inconsistent with delivering that action. Then we would have to think again. So if we see a significant decline in the medium-term inflation outlook, that will be the trigger for revising the net purchase schedule.

Your guidance also says that you will lift interest rates sometime after the end of purchases. Could that “sometime” be sometime this year?

I don’t know. We are trying to be as clear as we can that monetary policy will be data-driven. So there are scenarios where it would be appropriate to start to normalise interest rates later this year. And then, of course, there are scenarios where it could be appropriate to move at a later point. This is why this phrase “sometime after” was deliberately introduced. It’s supposed to explain and emphasise that the timing of interest rate moves will be in line with the incoming data.

The end of the third quarter is six months from now. There is a lot of uncertainty surrounding the outlook given the war and the pandemic reopening. By the way, the latest COVID-19 issues in China show that the pandemic continues to add to uncertainty. Under these conditions, trying to give calendar guidance is not helpful. The commitment is that our monetary policy responses will ensure that, in the medium term, inflation will stabilise at 2 per cent.

Your severe scenario, which includes a complete disruption of oil and gas supplies from Russia, still sees 2.3 per cent growth for this year and next. That is very different from what the Government in Berlin is saying. It warns that a complete ban would throw Europe into a recession. How do you explain this huge discrepancy in the assessment?

First of all, let’s be clear that these were two scenarios, but these were explicitly not intended to be tail scenarios. So worse scenarios can be envisaged. Our scenarios assume that the interruption of energy supplies is just temporary. These assume that later this year Europe will essentially have found alternative sources of supply. If you impose a longer period of interruption of energy supplies, then you would have a more significant drop in GDP. So that’s where people can make different calls about how long the interruption in supply might be. It is also important to remember that the European economy is recovering from the pandemic-induced recession. So you need to overlay the effects of the war, which is a substantial adverse hit under all scenarios on the European economy, on the fact that, at the very least, the European economy is normalising from the pandemic. For example, the summer tourist season should be a lot stronger than last year. At the same time, some of the supply chain issues that were there last year are easing. For example, towards the end of last year the car industry recovered to some extent from having been severely hit by the semiconductor shortage. Now there are new supply chain issues, but it is important to recognise that both the easing of some of the bottlenecks and the basics of allowing the services industry, travel, tourism and entertainment to normalise do give momentum to the European economy. Regardless of emergency scenarios, it still means GDP is going to be a lot weaker than without the war. It’s a bad news situation. It’s a downgrade to the recovery under all scenarios, whether it turns out to be such a strong downgrade that our economy shrinks for a while is not the only way to think about it. Even if the economy continues to grow, it’s still a very negative event.

So if Europe failed to replace Russian energy imports by year end in case of a boycott, you see the risk of a recession?

I think the analysis would say that the longer you see a situation where there is a more prolonged set of supply chain issues, that would create risks for next year. So again, that’s something that the ECB will be continuing to look at. But, in the end, all of this falls back to essentially our overall framework, which is saying, look, we’re in a world of extreme uncertainty. We tried to give some references to deal with the uncertainty by publishing several scenarios. But we also tried to be clear that these scenarios don’t cover every possibility. These focus on, essentially, a temporary hit to the economy rather than a long-lasting hit. I think that should be crystal clear. So these are not predictions. These are scenarios. The most important issue from our point of view is that we’ve laid out a monetary policy framework with flexibility and optionality, which is expressly designed to be capable of responding to whatever unfolds in terms of the medium-term outlook.

Picking up on your points about the impact of the war. We’d like to get your views on how that’s going to manifest itself. Is it potentially the impact on energy, or is it supply chain issues, or food exports, etc? Where do you see the danger zones for the European economy from the war that is now happening in Ukraine?

Let me divide the issue. There are mechanical channels, where the important factors are energy, some supply chains, food… that’s for sure. But to recall, energy is a global market. Even if the overall global supply of oil and gas is more limited, there are options for Europe to find alternative suppliers eventually. The world will have to deal with less supply, so collectively the world faces an issue, but also for Europe there will be options there eventually. So then the bigger issue is if this is a trigger for a big decline in sentiment. All economies operate on confidence, and what we see now in terms of these first readings of confidence indicators is a concern. But essentially this goes back to the course of the war, diplomatic possibilities and so on. There are two possibilities: either this initial confidence shock will become embedded and people will settle into a long period of being hesitant, or, if the war finds a diplomatic solution sooner rather than later, those confidence indices could maybe recover. So this is why essentially, right now, uncertainty dominates. I can conceive of each of those paths. One is that we get more clarity about the possible diplomatic solutions to the war and these confidence indicators recover, or we settle into a prolonged period where, essentially, people are reluctant to make significant decisions given the uncertainty. And so if you have a pausing of investment plans, of recruitments plans, pausing of consumption, then clearly that is a pretty general way to slow down the European economy, even if quantitatively the direct exposures to the Russian economy and Ukraine are limited enough.

There doesn’t seem to be any sign of that at the moment – pausing of investment plans, recruitment, consumption.

The timeline is that these sentiment indices are leading indicators. We don’t see the investment decisions on a day-by-day basis. These sentiment indicators have proven in the past to be a leading indicator of what might happen next. But again, let me come back to the basic point: there’s an overlay here of all of that, side by side with the pandemic recovery, which I do think is ongoing. There will be a reopening of travel and tourism once the latest wave of COVID calms down, and people will be more willing to go out to restaurants, cinemas and so on. So it’s difficult not to overstate the basic point here: Europe was not in a normal economic situation when this war began. It was in a situation where – and remember this winter we had a further holding back of the European economy with a new wave of COVID – sooner rather than later this artificial holding back of the services sector in Europe will come to an end, and that should lead to a significant rebound in activity. This is why it’s not a normal war situation – it’s side by side with a normalisation process in the economy, which we think will continue.

On energy – you commented a couple of times that there are other options for Europe to find alternative sources in the event of a curbing of Russian imports – by the end of the year – that sounds quite optimistic. There are a lot of infrastructural and other issues that have to be overcome. Do you think that it is realistic?

I’m not saying there’s a perfect replacement, but compared with the immediate shock, over time alternative sources of oil and gas can be found. I’m not saying that to make the lack of Russian supply irrelevant, but there is an adjustment mechanism. So I do think, again, this will have spillovers to other parts of the world, as of course Europeans have to pay high prices for energy. But high prices for oil and gas will have spillover effects on other parts of the world which are also energy importers. Just think about Africa, Latin America, South-East Asia and so on, which will probably suffer more from higher prices.

Given that your severe scenario assumes that there will be a replacement by the end of the year, you must think that that is a realistic scenario, right?

To a degree. There is a lot of effort to find alternatives. Part of the adjustment will also be a change of behaviour. Over time, households will find ways to try to reduce their energy usage in particular. So there will be behavioural changes which will also help to reduce the initial impact of the energy shock. But what I’m saying is simply that we’re just at the end of the first quarter here in late March, we’re talking about nine months until the end of the year. To say that there wouldn’t be some success or some effort to find some alternatives in the course of this year would not be plausible… I think there are going to be a lot of efforts to find alternatives. I’m not saying that it totally eliminates the impact, but when you have a possible supply disruption, the biggest impact will be at the start, when you have not had time to find alternatives. And every month as Europe races to find alternatives, that worse impact at the start becomes weaker. And that’s just simply the straightforward adjustment. When you have a surprise interruption to supply, the maximum impact will be at the start and then, over time, the effort will be there to find alternatives.

Just coming back to something at the beginning – this energy shock, that it was quite sudden and governments weren’t expecting this. But last September or October at the Eurogroup you had countries like Spain warning – pre-Ukraine war – of spiralling prices. Were the ECB or policymakers too slow to recognise the threat of rising energy prices?

Essentially there’s a two-phase issue here. Definitely, at the bottom of the pandemic shock – I think the price of oil was USD 25 in May 2020 – prices were extremely low. Then a recovery took place in the first half of 2021, which could simply be seen just as a demand recovery. Then there was a new phase in the second half of the year, and by the autumn the price of oil was around USD 80. But what’s happened is that now it’s USD 120. So we’ve had this extra phase. There was already a lot of debate about how we handle USD 80. Pre-pandemic – between 2014 and 2019 – the price of oil was fluctuating, but basically between USD 40 and USD 70 a barrel. So you’ve had different levels of intensity. There was already a pretty big debate in the autumn about the implications of USD 80 a barrel. Adding 50% more to reach USD 120 was pretty significant. Another element which was new was gas. Gas, as you know, has an unusual pricing structure. You had a really large increase, so that remains a significant issue. If there was some entity out there that was calling that this was going to be an outcome with a high probability, we missed it, but by and large it is something the world collectively missed. We can always reflect on whether we can do better.

Just to clarify, when you were talking, for example, about USD 80 in November, that was 2021.

Yes. Our analysis would be that in the first half of the year, rising oil prices could simply be seen as the recovery of the world economy. In the second half of 2021 what seems to be happening is that supply was not keeping up. There seems to be supply issues with oil, you know OPEC+ and now with Russia. But then there are supply issues with gas as well. So essentially there are a range of factors at work. When it became a supply side issue in the autumn, there was concern around that. The normal relationship between economic activity and energy prices was thrown off by the fact that basically interruptions to supply were becoming more important.

One thing I wanted to ask was your views, or where you see the debate, on the fiscal side: reform of the Stability and Growth Pact rules – are they fit for purpose anymore? What’s your view on that?

Personally, back at the end of November/early December I spoke at a European Commission seminar. But what I said is more or less similar to the ECB statement on this. There is an identified reform proposal which focuses on having an expenditure rule as the most important component. Essentially, what that means is that governments should line up their fiscal plans with their medium-term economic prospects. The expenditure rule has that feature.

Second, we would also agree that you still need a debt anchor. Those countries with high debt do need to see these debt ratios come down. But I would argue that essentially interest rates should be a lot lower than the historical norm when the Maastricht Treaty was written. The coefficient there – there is currently the one-twentieth rule – in my intervention back in December I suggested a 0.3 per cent coefficient. It’s still a significant coefficient but a lot milder than 0.5.

The third element I would emphasise is that the pandemic has shown the value of common European funding, whether that’s SURE or Next Generation EU. I do think that we face very significant common challenges. Climate, in particular, but you can also think about other dimensions of that. In response to common shocks, having common forms of finance, either of the SURE dimension or Next Generation EU, should be part of the broader fiscal recipe for Europe.

The Stability and Growth Pact is about national fiscal policies, but it’s really a two-dimensional debate – how to run safe national policies. And the point I’m making here is that all of these shocks – the pandemic, the war – underline the value of fiscal buffers, of having some spare capacity. And this is why keeping an eye on debt ratios is important, but then also the balance between national and European level issuance is important.

Do you think that the war in Ukraine and the energy issues that has thrown up has strengthened the case for these kinds of common forms of finance?

Definitely. It underlines or reinforces one of the big topics of the next decade, which is the carbon transition. This relates not only to the basics of the Paris Agreement, but – specifically in the European context – also to the interconnection between energy and security and autonomy. For Europe, unlike the United States, for example, more than 90 per cent of our energy is imported. Doing more to increase renewables, for example, has had an additional dimension: it reinforces the case for having a vigorous transition plan. And since it’s a common agenda – the climate is shared – to me, the case for European-level initiatives should be closely studied.

Do you think the war will pave the way for more permanent joint bond issuance?

I don’t find that way of thinking about it to be the best way of thinking about it, because it’s not a case of whether an initiative is temporary or permanent. It’s essentially the question: at a point in time, is Europe using the best device to respond to the challenge it faces? In the case of the pandemic, I do think Next Generation EU was fundamental to the European recovery from the pandemic. Then of course, many people say: is the pandemic the only type of development that would justify common funding? We’ve talked here about two factors. One is climate being a common challenge, where common types of funding could be important. And of course the war itself could lead to related fiscal challenges across countries. But let me emphasise: we have two models of European issuance during the pandemic. Both have a role to play. One is SURE, which is basically on-lending to national governments, so there isn’t the kind of sharing of liabilities. There’s a clear limit to that type of lending programme, but there is still a lot of value to that versus the more joint nature of the Next Generation EU initiative. It’s not about permanence, it's about diagnosing the best answer to the challenge you face.

Perhaps a very big picture question towards the end. There’s been a lot of debate about what this event means for the global economy, and the pandemic and the war spelling the end of globalisation. Is that a view that you would subscribe to?

I think there are several levels to that. It’s a little bit reductive to boil it down to that phrase, “the end of globalisation”. There is a significant issue about Russia in particular, how the Russian economy will interact with the rest of the world economy. That’s very specific and it’s significant for certain commodities in particular. After that, of course, there are maybe two other forces at work. One is the resilience of supply chains. The resilience of supply chains could involve making supply chains more local, but it could also involve just making sure that multiple suppliers are available, which does not necessarily have a geographic component. Because you could have multiple suppliers around the world, but you’re less exposed to any one choke point – if you like – if you have that. On that side, a lot of what we think about globalisation could be retained. And then, of course related to strategic autonomy, for key sectors which overlap with security, there is a question about having autonomy at European level.

You didn’t mention China, which is interesting.

China is a big part of the world economy. Again, all of that has implications. Those are significant issues. Let me point out a trend that is a little more in the opposite direction, which is digitalisation.

Digitalisation essentially does mean that there’s a force to bring economies closer together, because essentially you no longer need to travel to interact with suppliers from another jurisdiction. If you think about the services industry – and of course we already know that within Europe there is a lot more cross-border activity – digitalisation is a force pushing in the opposite direction to anti-globalisation. It should make it more possible to sell services around the world, to buy services around the world. Connected to that is automation. The debate about globalisation should be paired with technological developments, because it goes back to what’s really driving the world economy: the possibilities created by IT developments, including automation, a greater role for robots, a greater role for services trade. I do think it’s important to put globalisation side by side with a general digitalisation dynamic.


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