Interview with Die Zeit
Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted on 22 March by Kolja Rudzio
29 March 2023
In recent weeks, banks have collapsed in the US and Switzerland. Could the same happen in the eurozone?
Let me first strongly emphasise that what we’re seeing in the euro area in terms of tensions is a spillover from the US and from Switzerland. And please remember that we had a severe banking crisis in the European Union 15 years ago. As a result of that, we now have very tight regulation and very tight supervision of the banks. So our baseline is that the European banking system has a lot of capital and banks have been prudent in their lending decisions.
“Baseline” means you think this is the most likely scenario.
Yes. Of course we’re closely monitoring developments and are on our guard, but we don’t expect to see the same situation as in the US or in Switzerland to be the most likely scenario here in the euro area.
You don’t expect it, but you can’t rule it out, can you?
The history of banking teaches us that it’s very important to maintain confidence. We don’t have any reason to believe that a major problem would emerge. However, if it did, the ECB is able to respond. We have many tools, we can provide liquidity, and we can make sure we don’t see the types of bank runs that were evident in these examples.
If banks had to be rescued in the EU, would taxpayers have to pay for it again?
Here in the European Union and in the euro area, one of the most important lessons was to make sure the banks have a lot of capital, so that they are very capable of absorbing losses. The European banking system is well capitalised and profitable. And the macroeconomic outlook is positive. These are not the circumstances in which, in the baseline, we expect to see the banking system come under significant pressure.
At a recent conference, you called the financial turmoil we just saw a “non-event”. Could you explain that?
We’ve seen significant issues in the US and in Switzerland. But in the end, only certain types of banks with very specific problems were involved. We don’t see that as a general issue in the banking system. Of course people ask questions immediately after a policy intervention such as in the US or Switzerland. But I think it remains the case that there’s no direct read-across to the euro area. In the baseline, we expect these tensions will settle down.
That means a non-event?
Yes, from a macroeconomic perspective. The next level up from a non-event is if the banks become risk-averse because of a loss of confidence. Then there would be some impact on the economy, but it would still be limited.
Are you seeing that already?
It’s too early to tell, but this is something we’ll be looking at in the coming weeks. The third scenario is if it becomes more severe. But in our jargon, it’s a “tail event”. It is at the far end of the probability distribution – very unlikely. So we’re monitoring, but it’s still too early to extrapolate that this is going to be a significant issue.
Were you surprised by the banking problems we just witnessed?
For many years, the European Central Bank and other institutions have run projects playing through what happens if interest rates go up suddenly. I, by the way, participated in one of these projects around 2015. What stress such rate rises might put on the financial system is something we’ve studied for years. The exact details of which particular bank, what particular scenario, of course, always contains an element of surprise.
But was the high pace of the rate hikes you decided upon at the ECB perhaps a surprise for people?
I don’t think it really has been something that’s so sudden or severe. Let me make a number of observations here. Number one is: behind the increase in interest rates is the fact that inflation rose quite quickly. In the context of inflation rising that quickly, it would have been a surprise if interest rates did not also go up relatively quickly. Number two: these increases were from super-low levels. It should not be surprising to anyone that rates went from -0.5 per cent to, let’s say, about 2 per cent. That essentially was normalising policy. That was always expected, even if there was the question of the timing of it. Now, because of high inflation, we needed to do more. This is why we’ve brought rates above their long-run value of about 2 per cent, now to 3 per cent, and we’ve signalled they will go higher, if needed. The third point is we started really around December 2021, so already 16 months ago. First of all, we ended the pandemic emergency purchase programme, then we ended Quantitative Easing in general in June last year, then we moved rates out of negative in July. But already from January onwards, the market understood that rate hikes were coming. So we have always gone step-by-step, in part to allow the financial system to adjust.
Are these tensions in the financial system the downside of the zero interest rate policy which central banks have been pursuing for so many years?
I don't think that diagnosis is correct. The origin of the low interest rates was inflation that was too low, and the origin of the rising interest rates now is that inflation is too high. So I think what you described there is essentially a reflection of the actual issue, that inflation rose quickly. And it is clear as daylight that high inflation emerged because of the pandemic and because of the war in Ukraine. Of course, it is our job here at the ECB to make sure now that inflation comes down quickly to 2 per cent.
Inflation rose in 2021 and reached 5.1 per cent in January 2022 – before the war. So isn’t this development at least partly due to monetary policy?
No. Between summer 2021 and February 2022, when the invasion started, we had very strong goods inflation because of the pandemic and supply bottlenecks. Second, the European economy had just reopened after all the lockdowns. People were keen to go on holiday or were more relaxed about going to a restaurant and spending their money. Third, Russia had restricted energy supplies even before the invasion began. So we had three factors driving inflation at the beginning of 2022: bottlenecks, the war and energy prices, and the reopening of Europe. The inflation we’re seeing stemmed from these unusual factors. Finding the solution to that inflation, that’s our job.
You don’t see any misjudgement of the inflation by the ECB at that time?
Given the information we had at the time, I think we made reasonable choices. What is essential is that, if you see the world changing, you respond. We reduced the amount of money we put into the economy by buying bonds – from over one trillion euro in 2021 to net zero by June 2022. That was a huge turnaround. And many people predicted we would be reluctant to raise interest rates.
Weren’t you too reluctant? You only started raising interest rates in July.
Our priority in the first half of 2022 was to end this large bond-purchasing programme and start hiking rates afterwards. And the markets understood early on that we would raise our rates. For example, mortgage rates here in Germany also started to rise well before we began lifting our ECB rates. Thus the tightening has effectively been there since the end of 2021.
Let’s look forward. You predict that the inflation rate will go down rapidly from 10 per cent at the end of last year to 2.8 per cent at the end of this year and then further towards the inflation target of 2 per cent. Why you are so optimistic?
It’s a mix of factors. Energy prices are falling. Food prices are still very high and that is what people see when they go to the supermarket. But if you look at the earlier stages of production, at the farmgate prices, at the prices of the food ingredients, you will recognise: all of these have turned around. And history tells us that this will eventually lead to lower retail prices. Another factor: we have fewer supply bottlenecks. Car firms, for example, are able to get their microchips again. Therefore, the prices of goods should stabilise. Wages will rise on the other hand, but our overall assessment is a rapid decline of inflation at the end of this year.
Joachim Nagel, the president of the Bundesbank, warned recently that “price pressures are strong and broad-based across the economy”. How does that fit with your rosy outlook?
I agree with that statement. Our President, Christine Lagarde, said something similar. We are in fact probably in the most intense phase of inflation. It takes some time until the dynamics which I described reach the customer. Let’s say you’re a producer. You paid a high price last year for your inventory. When you sell these goods now, you’ll probably seek a correspondingly high price, even if your input purchase prices are already declining. So right now we still have this intense inflation pressure. Although, when you look further ahead, you see the improvement, gradual in spring and summer, but quite a bit in autumn.
Does this mean there is no need for more rate hikes?
Under our baseline scenario, in order to make sure inflation comes down to 2 per cent, more hikes will be needed. That is absolutely our diagnosis. If the financial stress we see is non-zero, but turns out to be still fairly limited, interest rates will still need to go up. However, if the financial stress we talked about becomes stronger, then we’ll have to see what’s appropriate.
So there is a trade-off between fighting inflation and stabilising banks?
No. If this financial stress weakens the economy, it would automatically reduce the inflationary pressures.
You mentioned rising wages. Do you see any sign of a wage-price spiral which could fuel inflation?
So far, rising wages have not been an important source of inflation. Last year a lot of the price increases could be put down to increased profits and rising energy costs. This year we think there’s a handover. We expect wages to go up more quickly as unions react to the high inflation of last year. But it’s very important for everyone – workers, firms – to recognise that inflation will be much closer to 2 per cent next year and in 2025. The wage-price spiral is a scenario which happened in the 1970s when expectations became entrenched that inflation would be high every year. This is not what we’re seeing. We’re seeing wage increases that are higher than normal, but in the grand scheme of things they look reasonably fair. But we have to keep an eye on this.
In Germany unions are demanding a pay rise of 10.5 per cent for the public sector. Could this trigger more inflation?
I’m not going to comment on any one particular set of negotiations. What I would say is, sometimes I read headlines of very high wage increases. But when you look at the details, there is often a one-off payment, which doesn’t increase labour costs permanently. Or the wage increase might be spread over 18 or 24 months. So the true increase per year is lower.
At what percentage does a wage increase start to get dangerous in terms of inflation?
Let me cite what we have in our forecast. Remember, under this forecast, inflation is coming down to 2.8 per cent at the end of this year and then continuing to improve towards our goal of 2 per cent. We assume wage growth of 5.3 per cent this year and 4.4 per cent next year. We’re putting a lot of effort into tracking wage settlements week-by-week, and so if we saw them coming in above that, then we would start to become more concerned.
ECB President Christine Lagarde said there should be a fair burden-sharing between employees and companies in this time of high inflation. What does that mean?
The spectacular rise in energy import prices was the trigger for high inflation. We’re paying more for imports of oil and gas from other countries now. Which means that there is less income to be distributed in our economy. There is a collective loss. And the question is: how much should the workers’ earnings go down and how much the profits of firms? The loss has to be absorbed somehow if we want the EU to remain competitive and to do well in global business.
Is the burden-sharing fair at the moment?
Well, profits did better than wages last year for a number of reasons. One reason, for example, is that wage negotiations take time. This year we expect wages to increase more. And we believe that firms will have less space to increase their profits through higher prices. For many reasons: demand should cool off and the supply bottlenecks should ease, for example. So the share of the burden changes over time.
But in general your outlook seems quite optimistic. You expect inflation to fall quickly while the economy grows. Does it mean we’re going to achieve a so-called “soft landing”?
It is possible. Some might object that it takes a recession to bring down inflation. But we have a very unusual situation. We’re coming out of a pandemic and out of a very severe energy crisis. We’ve lost so much growth momentum in the pandemic that it’s possible for the pandemic recovery to continue and for inflation to come down simultaneously.