Interview with Süddeutsche Zeitung

Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Meike Schreiber und Markus Zydra on 18 December 2023

22 December 2023

Inflation has recently fallen to 2.4%, more rapidly than expected. Are you satisfied?

We will only be satisfied if inflation falls sustainably to 2%. We currently foresee that inflation may pick up again temporarily in the near term, as base effects in energy prices reverse and government support measures expire, such as in Germany the gas price cap and the reduction in VAT on catering services. We expect that inflation will then gradually drop to 2% by 2025. So, we still have some way to go and we will see how difficult the famous last mile will be.

But you do want to go the last mile?

We must go the last mile: we have an inflation target of 2%.

Would 2.1% not be enough?

We want to return to 2% on a sustainable basis.

There is war in Ukraine and Gaza. How much do global crises influence the central bank’s work?

Geopolitical shocks lead to uncertainty and thereby affect economic decisions. At the same time, they can also push up energy prices and hit world trade by disrupting supply chains – which we see happening in the Red Sea right now. Geopolitics can also influence the green transition, if the supply of commodities, such as those required for producing solar cells or batteries, is restricted for political ends. All of this affects our core business: the fight against inflation.

Your policy rate decisions are data-dependent, as you always emphasise. How useful are historical data to you when, as at present, the global situation is constantly changing fundamentally?

Historical data are valuable as one can derive patterns from them. But the world can change very quickly. We then need to adjust our analyses, without discarding historical knowledge. The macroeconomic environment has indeed changed radically over the past few years. We came out of a long phase of low inflation and then – owing to the pandemic and Russia’s war of aggression against Ukraine – quickly entered a completely new world of soaring inflation. Looking at the period of low interest rates would hardly help. But by analysing the great inflation of the 1970s we can draw lessons on how we should react today.

Inflation was very low in the past decades. Was that mainly because of the central banks’ sound monetary policy? Or was it partly luck, thanks to globalisation for example?

It was both. After the great inflation of the 1970s, monetary policy changed fundamentally. Central banks have become more independent and have a clearer mandate: price stability. This has increased the credibility of monetary policy. But there have also been macroeconomic trends, particularly globalisation and China’s entry into the world market, which played an important role and brought down inflation.

Has the fight for stable prices got tougher?

Since 2020 there have been several severe external shocks. That makes monetary policy more challenging.

Will inflation be higher in future than it was before?

Let me first assure you that we do not have any intention of adjusting our inflation target of 2%. At the same time, we may be confronted with more supply-side shocks. And these could turn out to be inflationary, even though that is hard to predict. Climate change, for example, drives prices, we see that already. Extreme weather can push up food prices, low water levels in the Panama Canal increase transportation costs, and carbon taxes raise the price of fossil fuels. A partial withdrawal from global supply chains can push up inflation as well. But there are also opposing effects such as the advance of artificial intelligence, which could boost productivity growth and thereby temper inflation.

When you joined the Executive Board in 2020 you wanted to smooth the fractious relationship between Germans and the ECB. Did you manage to do so?

The determined fight against inflation probably helped Germans reconcile somewhat with the ECB. It has enabled us to strengthen the ECB’s credibility.

But the ECB was too slow in combating inflation. Many people haven’t forgotten that.

We acted relatively late, but all the more decisively. We sharply increased interest rates within a short time, and there is no doubt that monetary policy has contributed to the fall in inflation. Inflation was initially caused by rising energy prices and disrupted supply chains owing to the pandemic and the war. These constrained aggregate supply, while demand remained robust. Determined monetary policy is essential in such a situation to dampen demand and anchor inflation expectations. We succeeded in doing that. It is important for people to know that the central bank will bring inflation back to its target of 2%.

Inflation has fallen, but the higher prices continue to put pressure on people.

The prices are clearly higher than before the pandemic, and monetary policy cannot roll back that increase. And people would not be better off if we plunged the economy into years of deep recession just to bring the prices back to their old levels.

Would you manage, though?

With massive consequences, but this is not the task of monetary policy. An energy price shock makes an economy that is reliant on energy imports poorer overall. Somebody has to bear those losses.

When you have achieved your 2% inflation target, is there a risk of forgetting that the high level of prices is as good as entrenched now?

We target inflation, not the price level. Also in the past, it was never our goal to balance out inflation rates that were too low with higher inflation in the future.

The quick and sharp interest rate hikes have led to banks suddenly making record profits. Is this fair?

Our decisions are guided by our price stability mandate. But they have side effects, including their impact on bank profits. Banks have lent money at higher rates, but they have not passed the higher interest rates on to their depositors immediately or in full. But we expect banks’ profits to be under more pressure in the future because banks will face higher funding costs and rising credit default risks, while lending is weakening. Banks would therefore be well-advised to use these short-term profits to build up a buffer against future losses.

But banks tend not to do that, opting to pay out dividends instead.

Erring on the side of caution would certainly not hurt the banks.

The high profits are also boosted by the 4% deposit facility rate which banks receive on their excess reserves. The ECB could shrink these deposits by raising the minimum reserve requirement. Why has it not done so?

In July we decided to no longer remunerate the minimum reserves while keeping the minimum reserve requirement at 1% of the minimum reserve base, which consists mainly of customer deposits. The minimum reserve requirement is not an effective way of compensating the remuneration of excess liquidity. Large banks have the highest excess liquidity, smaller banks have less. At the same time, the smaller banks are mostly funded by deposits. This is why they would be disproportionally affected by higher minimum reserve requirements.

By the same token, large banks are subsidised with the deposit rate, because many smaller lenders only have low excess amounts that are remunerated.

Banks are not subsidised. But the effects of our measures do vary. For example, during the pandemic the ECB granted longer-term loans that have strongly benefited smaller banks. At the same time, until recently banks were charged a negative interest for their excess liquidity, and that affected large banks more. There are no banks that are systematically at an advantage or a disadvantage. All banks are important for the transmission of monetary policy.

The ECB could sell all the sovereign bonds – that would solve the excess reserve problem.

The ECB’s balance sheet has already shrunk significantly. This will continue in the coming years, thereby reducing excess liquidity. But the primary monetary policy instrument is ECB policy rates. The reduction of our balance sheet is happening gradually in the background, also to avoid market turbulence. While we are not expecting any, we are not taking any risks.

The ECB is making losses now because it has to pay high interest to banks while holding low-yielding bonds. A central bank that is making losses doesn’t look too good.

Our bond purchases were always guided by monetary policy considerations. Take the pandemic emergency purchase programme. This measure probably averted a serious financial crisis that would have wreaked havoc on the economy and people’s lives. The ECB’s losses cannot be viewed out of context.

But they do damage your reputation.

We always assess whether our measures are proportionate, and losses can damage the central bank’s credibility and independence. In the future, this might lead to a certain reassessment of bond purchases.

How do you assess the ECB’s bond purchases?

Bond purchases can be employed for achieving two distinct goals: price stability on the one hand, and market stabilisation on the other. They were very successful in stabilising the financial markets. But we could ask ourselves how effective bond purchases were in combating low inflation. At the time, one problem was the very restrictive fiscal policy. Governments failed to make use of the low interest rate period to invest, and this made life difficult for monetary policy. The lesson here is that fiscal and monetary policy need to pull together.

When you joined the ECB in 2020, inflation was low, the key interest rate below zero and central banks were making profits. This has all changed. How has it affected you?

I have learnt that the world can change much more quickly than you think. The central bank needs to react swiftly in such situations, and this is a challenge. But I think that we have done pretty well in the past four years.