Weidmann: I would make the exit swift
Interview published in Börsen-Zeitung
Interview with Jens Weidmann conducted by Claus Döring, Detlef Fechtner and Mark Schrörs.
Translation: Deutsche Bundesbank
Mr Weidmann, to begin, there’s one thing you do need to explain to us: what’s so bad about euro-area inflation running not at the target rate of just under 2 % but at 1.3 %, as it does currently, or at 1.6 %, as the European Central Bank (ECB) has projected for 2019?
Fundamentally, nothing whatsoever. But it is simply the case that many central banks – not just the Eurosystem – aim for a specific, slightly positive rate of inflation, one that is generally in the region of 2 %. The fact that central banks gear their monetary policy to a particular target rate, and that market participants therefore base their economic decisions on this policy, is a matter of credibility and is also key to the effectiveness of monetary policy.
But still, many people, particularly in Germany, think that the world has been turned upside down, with an ECB pulling out all the stops to ignite inflation rather than fight it, as it did in the past.
And yet people often forget that the Bundesbank was not looking to achieve 0 % inflation in the days of the Deutsche Mark either. Its last monetary targets back then were geared to an inflation rate of 1.5 %. There are, after all, good reasons to allow the price level to rise slightly. One is that we are looking to keep a certain distance from the zero lower bound, a level which can complicate the work of monetary policymakers due to nominal rigidities and force them to adopt unconventional policies. In any case, I have yet to come across any compelling scientific evidence that fundamentally calls the 2 % target into question.
A number of academics, however, go as far as to advocate a higher inflation target of 3 % or 4 % – and there are even some central bankers, especially in the United States, who have taken fancy to that idea.
You’re right – there are vastly different opinions over whether the target rate of inflation should be adjusted, and if so, in which direction. The desired, temporarily stimulating real interest rate effect of a higher target rate would, incidentally, come at the cost of a lasting increase in the cost of inflation. Plus the central bank would be expected to repeat this “cheat”. At the end of the day, this might end up making it more difficult for the central bank to manage inflation expectations. Of course, it is legitimate to question established concepts such as the definition of price stability, but for the sake of your own credibility, you should have this discussion once you have achieved your target and not before. This applies, above all, to the single currency area. That kind of debate would not exactly strengthen what is – even at the best of times – a weakly held belief in adherence to the rules at the European level. Another question is whether a central bank must always try to achieve the desired rate of inflation immediately and at any cost.
And what’s your view on this matter?
I have always stressed that our definition of price stability is geared to the medium term. As for which instruments we use and how aggressively we pursue our objective, we should never lose sight of this mid-term orientation, because that is what allows us to take account of any side effects caused by our policy measures that may have knock-on effects on prices further down the line.
Growth is around 2 % and inflation just under 1.5 %, and yet the ECB’s monetary policy stance is currently more accommodative than even at the peak of the global financial crisis. Is this really still appropriate?
For us, the sole benchmark for our monetary policy stance is inflation. And looking through the short-lived volatility caused by energy prices, our forecasts suggest that inflation will continue to grow at no more than a muted pace in the near future. I do, however, agree with your point that the current degree of monetary policy accommodation is open to discussion and that different points of view can be held on the issue. That’s also the case in the ECB Governing Council. And of course, the use of the individual instruments is another matter that can be brought into question.
The ECB is projecting 1.6 % inflation for 2019 – that is below the target of just under 2 %. Is there any leeway at all to slow things down in terms of monetary policy in 2018?
The ECB Governing Council has never specified that the medium term constitutes exactly two years. And there are good reasons why the journey back to 2 % inflation after such a severe financial crisis is taking more time. My view is that the inflation path mapped out in the projection will lead us to our goal. Bear in mind, of course, that this inflation path is based on a certain degree of accommodative monetary policy stimulus. However, I see nothing in our June projection to suggest that there is currently an urgent need for further action next year, especially not yet another extension of the purchase programme. Remember, that isn’t what the ECB Governing Council decided when the projection was presented.
So how urgent is it to discuss, and communicate, the future of quantitative easing (QE) in a way that makes the path ahead visible to the markets?
Needless to say, communication is hugely important. However, above all, we need to explain to market participants that bond purchases cannot go on indefinitely and that if we taper the net purchases, that does not mean we are applying the brakes in terms of monetary policy. We just wouldn’t be putting the pedal ever more to the metal. Because we remain in highly accommodative monetary policy mode not only when we press ahead with additional asset purchases, but also when we stop making net purchases and merely reinvest. Even in this case, very substantial asset holdings will be left on the balance sheets of the Eurosystem central banks, and this, so the current thinking goes, is what determines the degree of accommodation.
You highlight the importance of asset holdings. Does this not mean that monetary policy in the euro area will stay highly expansionary for years on end?
Yes, that is correct. And that would even be the case if monetary policy were tightened. Policy will continue to be supportive of economic activity and price developments for quite some time to come.
All this sounds as if you do not see any need whatsoever for QE purchases to be continued at all beyond the current end date of the end of 2017. ECB President Mario Draghi, however, has always emphasised that there would be no abrupt end to QE.
The question of whether there is any need for further monetary policy action should be considered in isolation from what an exit should look like. We are all in agreement that the purchase programme should not be ended overnight. To effect an orderly exit that does not cause needless turmoil in financial markets, it would be necessary to gradually taper the programme, supported by appropriate communication.
Hypothetically speaking, if you alone could decide how QE should proceed in 2018, what exactly would you do?
Nice try, but I never forecast decisions by the ECB Governing Council.
Yes, but we asked what you yourself would do.
You can deduce from my view that government bond purchases should only ever be regarded as an emergency tool that I would be prepared to accept a less expansionary monetary policy stance and thus a slightly slower return towards 2 % inflation, and that I would make the exit swift.
Shouldn’t the ECB Governing Council already be sending some kind of signal in September?
The ECB Governing Council is right not to put itself under pressure by tossing specific deadlines around regardless of economic developments. At every monetary policy meeting, we ask ourselves whether our monetary policy is still appropriate and whether we need to tweak our message.
There are two options for phasing out bond purchases: the ECB could draw up a set plan in advance stating how and over what period of time it would like to reduce purchases to zero, or it could begin by tapering the monthly purchases and then review how it will proceed a few months down the line. Which option would you prefer?
The first option is nothing more than a form of forward guidance – essentially, an announcement of a longer-term policy stance in an effort to steer the markets. However, one thing is clear: the ECB Governing Council has formulated its current assessment in its forward guidance, but never considered this to be unconditionally binding for the future.
More of a step-by-step approach, then?
A clear exit plan does indeed have its merits in terms of communicating with the markets and the general public.
The discussion is being complicated by the fact that the ECB’s QE operations are increasingly hitting the central bank’s self-imposed boundaries. There is one rule than no more than 33 % of a particular bond or 33 % of the bonds from a particular issuer may be purchased, and another that the purchases are to be allocated to each country in accordance with the ECB capital key. ECB President Mario Draghi emphasises time and again that QE is flexible enough, but how flexible are these rules? The ECB itself has always underlined the importance of these rules by pointing to the ban on monetary financing of the public sector and the monetary policy nature of the programme.
I believe that the rules the ECB Governing Council has set itself are highly important for exactly that reason. Government bond purchases blur the lines between monetary and fiscal policy, and they have made us the largest creditor of the euro-area countries. This proximity poses a threat to our independence. Furthermore, if the capital markets are to encourage fiscal policymakers to embrace fiscal prudence, it is critical that market mechanisms generally continue to function properly. From my point of view, a change in the parameters – which is sometimes discussed rather carelessly, in my opinion – would have considerable negative repercussions for those mechanisms. A clear sense of scepticism is also apparent in the Federal Constitutional Court’s decision to refer the government bond purchase programme to the European Court of Justice.
The Federal Constitutional Court says that significant reasons indicate that the ECB decisions governing the asset purchase programme violate the prohibition of monetary financing and exceed the monetary policy mandate of the European Central Bank. Will this sway the debate about the future of QE among the members of the ECB Governing Council?
Needless to say, there must be legal constraints to what the Eurosystem can do, and that's the whole point of the court proceedings. The debate among the members of the Governing Council centres predominantly around economic rather than legal issues – that is, the monetary policy impact and side effects of government bond purchases. And from my point of view, the QE programme, which unlike the OMT programme is not specifically targeted at bonds issued by countries with poor credit ratings, has far more to do with monetary policy. Quite apart from that, it is important for the Governing Council's credibility that it sticks to the rules it has rightly set itself and does not appear to rewrite them whenever compliance would impose any kind of restrictions.
Another problem at present is the appreciation of the euro: this is not only dampening the growth prospects, but also hampering progress towards the 2 % inflation target.
You're right to say that, taken by itself, an appreciating euro can dampen future economic and inflation developments. But the stronger euro has come partly in response to the surprisingly robust recovery in the euro area over the past few months. Economic activity in Germany has been upbeat for quite some time, and even formerly crisis-ridden countries are now racking up clear rates of growth. So from that perspective, the euro’s appreciation could be seen as an expression of relative economic strength rather than as a potential drag on future economic activity. What monetary policymakers are talking about, however, is the fact that these positive economic conditions are not yet fully reflected in price developments. But our projections do indicate that domestic price pressures will mount over time as the economies see a continued rise in capacity utilisation levels.
So the strong euro doesn’t pose a problem with regard to financing conditions?
Financing conditions remain extremely favourable. Incidentally, we gauge the degree of monetary policy accommodation using broader indicators in which the exchange rate is just one of many factors. These, too, suggest that monetary policy has become slightly less expansionary of late. Then again, there are other measures, such as the Taylor interest rate, which indicate a continued high degree of monetary policy accommodation.
The tenth anniversary of the outbreak of the global financial crisis has recently come and gone. On this occasion, US Federal Reserve Chair Janet Yellen said that she expects no new financial crisis in our lifetimes. Do you share her optimism?
Our goal must be to reduce the likelihood of financial crises and, should they happen despite our best efforts, to ensure that their consequences are less severe. I firmly believe that the financial system is more robust than it was before the crisis. But of course there are still risks, such as those emanating from investors’ intensified search for yield. I'm talking about segments such as non-investment-grade corporate bonds or also a few European real estate markets. Cyberattacks also pose a new type of threat. As financial supervisors, a major topic on our agenda at the moment is the increased vulnerability – of governments, banks and businesses – to a potential interest rate hike.
But at the same time, deregulating the financial industry appears to be coming back into vogue, especially in the United States.
Of course, there is nothing to be said against examining individual regulatory initiatives critically, analysing their costs and benefits, and considering how they will interact. That is, after all, one of the topics on the agenda of Germany’s G20 presidency. But it worries me to see attempts in some countries to turn back the clock a long way in matters of regulation. Stanley Fischer, Vice Chairman of the Federal Reserve, hit the nail on the head a few days ago when he said that it was hard for him to understand why grown intelligent people would want to unwind regulation and go back to a status quo before the great financial crisis. When it comes to regulatory issues, too, it is crucial that joint agreements are put into action – and not just to the letter, but also in spirit.
That's precisely an issue that raised some doubts recently over the application of the bank resolution rules in Europe.
Politicians have promised to remove taxpayers as the first line of defence and to instead reinforce the no bail-out principle again in the financial sector. And they need to be true to their word. What's ultimately at stake is the functioning and acceptance of our market economy.
A debate is currently raging in Europe over the future of London-based euro clearing via central counterparties (CCPs) after Brexit. What would you like to see happen here?
As a central bank, one of our key concerns is that Brexit does not weaken either the supervisory regime or its powers to intervene. After all, central banks not only have an interest in the smooth functioning of the euro markets, but, in the event of a crisis, may be called upon to provide clearing participants with central bank liquidity. Bearing this in mind, the Commission’s proposals are heading in the right direction and, in extreme circumstances, would even allow a CCP to be forced to relocate to the EU. What is more, I would like to see the national central banks be given a stronger role in supervising euro clearing, seeing as they are the lenders of last resort.
Efforts are being made to tempt as many banks and as much business as possible away from London to Frankfurt – even by politicians. As a supervisor, does this worry you?
Of course, Germany is interested in having a strong, diversified financial centre that also has an international standing. At the same time, you are perfectly right. Frankfurt will become home to financial institutions that are not only very large, but also have very complex balance sheets. As supervisors, this will present us with fresh challenges. We are aware of this, which is why we are expanding our supervisory capacities at the Bundesbank and the ECB.
You say that the ultra-loose monetary policy also harbours risks to financial stability. But at the same time, you always say it's not up to central banks to influence asset prices.
For sure, it’s an undisputed fact that monetary policy can have undesirable side effects. But monetary policymakers cannot simply give up on their objective to preserve price stability because of those side effects. However, the financial crisis left us in no doubt that upheavals in financial markets can have quite serious repercussions indeed for price stability and our ability to safeguard it. That is why the monetary policy debate needs to take account of certain developments in financial markets in terms of their expected impact on inflation. And in principle, this line of thinking is anchored in the Eurosystem’s two-pillar strategy.
Judging by what some politicians say – in the US, but also in Europe – you could be forgiven for thinking that the sun is setting on the era of independent central banks. How much does this worry you?
Unfortunately, it was all too clear that criticism would intensify. I warned at the very beginning of my tenure at the Bundesbank that the crisis measures taken by central banks might set these wheels in motion. Their independence is, after all, an alien concept in our democratic system and can only be justified if they have a clear and narrow remit. The more broadly the central banks interpret their mandate and the more political their role becomes, the more their independence will be questioned. At the same time, the crisis has shown what powerful instruments central banks have at their disposal. This leaves politicians wanting more, and it is up to us, as stability-oriented central banks, to take a clear stand against any such desires.
Aren't central banks already in a bind, to all intents and purposes? They do hold around one-fifth of their countries’ overall government debt.
The government bond purchases have led to a situation where changes in monetary policy now feed into governments’ borrowing costs much more directly than before. Moreover, the interest that governments pay on the share of sovereign debt we hold is practically the same, whatever their credit rating. At the same time, of course, national central banks are more exposed to risk because they are the largest creditors. But the impact of normalising monetary policy on the sustainability of government debt should not prevent us from proceeding with the exit when the time is right from the point of view of price stability.
Do you expect to face stiffer political headwinds?
We will certainly need to show even greater resolve in this environment than in normal times.
And to wrap things up, one final question about who will take over from ECB President Mario Draghi in 2019 – your name crops up again and again. You've always said it is too early to discuss this topic, but you also mentioned recently that nobody should be ruled out from the start on the basis of their nationality. Does it irritate you when people say that a German cannot take over the reins because the ECB is based in Frankfurt and modelled on a German template, and because, in any case, Germany is too powerful within Europe?
Let me first of all say that it is indeed much too early to discuss this topic, and that it won’t get us anywhere at present. But coming back to your question: if that were the case, I would indeed be concerned, because a blanket exclusion like that risks undermining the acceptance of monetary union in individual countries. Imagine if we had said in the past that a Dutch, French or Italian person could not take the helm at the ECB. It would be just as absurd to say that this person could not be German. Just like any other member of the ECB Governing Council, the President is not permitted to represent his country’s national interests. Instead, the President performs a key role in ensuring that the Eurosystem keeps the promise it has made to preserve monetary stability.
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