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Interview 13.10.2017

“Low interest rates won’t go on indefinitely”

Interview published in WirtschaftsWoche

Interview with Jens Weidmann conducted by Beat Balzli and Malte Fischer.
Translation: Deutsche Bundesbank

Mr Weidmann, have you disposed of your share portfolio yet?

I have to disappoint you there as I’m not an active investor in shares. In my capacity as President of the Bundesbank that could lead to a conflict of interests. We have a very strict code of conduct in place, and rightly so. 

So what is your advice for investors: Should they sell now before a crash happens?

For the reasons I just stated, I’m not able to give investment advice either. That’s the job of banks and financial consultants. It's important that each and every investor makes their own assessment of the level of risk they are willing to take and when they wish to take action.

With the DAX currently standing at just under 13,000 points, it’s reasonable to wonder how much longer things can remain rosy.

Share prices are very high around the world, not least also on account of the low-interest-rate environment. German investors are traditionally rather wary of taking risks. However, in their search for yield, they have recently demonstrated a greater inclination to engage in riskier investments. As a basic principle, diversifying assets more broadly makes good sense. But here again I must emphasise that I am not urging anyone to enter or exit the equities market.

When Germans start taking greater risks, this is a sure indication that there’s a bubble.

If such activity is the yardstick, then we have not yet reached that stage. Their risk appetite has not increased all that much. But seriously: without doubt, valuations on the equity market, for example as measured by the price/earnings ratio, are fairly high at present. But then the macroeconomic outlook has improved lately, and this is also reflected in the prevailing share prices.

Valuations in the real estate market are even higher. Don’t you see any signs of overheating in this segment?

Our model calculations show that the real estate market in Germany is very highly valued in certain regions. In our cities, property prices lie 15 to 30 per cent above our model results. Talk of a bubble capable of threatening the smooth functioning of the financial sector would only be justified if the boom in house prices were accompanied by extravagant lending and greater easing of credit standards on the part of banks. And we can see no sign of this at present. 

But soaring property prices are undeniably a reflection of how the ECB has dragged its feet on this issue for too long.

It is indeed the case that greatly increased real estate prices are also a consequence of the highly expansionary monetary policy. But one should not judge monetary policy solely on the basis of developments on the real estate market or other asset markets. The ECB’s mandate is to keep consumer prices stable. Monetary policy would be overly encumbered if it were also tasked with controlling individual asset prices. The ECB keeps an eye on financial stability, conducts analyses, gives policymakers advice on how to act and can tighten national measures. But asset price management should not be added to its list of monetary policy goals as it is not suited for this role. We should not make the objective of maintaining price stability play second fiddle to the containment of hard-to-manage financial market risks. If we were to do this, monetary policy would soon run aground. 

Then again, refraining from doing so will deliver the same outcome. The financial crisis has shown where things end if we focus on consumer prices alone.

In my opinion, responsibility for the financial and sovereign debt crisis in the euro area should not be attributed to monetary policy in isolation. Other policy areas played a key role in events. But the aforementioned crises demonstrated that monetary policy can be overstretched if it is employed as the sole tool in solving a given crisis. Incidentally, my comments should not be interpreted as implying that asset prices are of no relevance to monetary policy. When they boom, this can have repercussions for consumer prices. Investors feel wealthier, prompting them to consume more, which in turn drives up consumer prices. An asset price crash can impede the effectiveness of monetary policy. 

So how should monetary policy deal with asset price bubbles?

I advocate that monetary policy be pursued in a symmetrical fashion. In the past, central banks have matter-of-factly accepted the emergence of asset price bubbles, then fought aggressively to fend off a slump once they burst. This has set false incentives whilst also contributing to excessive risk-taking. It follows that monetary policy should focus on responding to cyclical and consumer price fluctuations in a concerted manner. This means markedly easing monetary policy in the event of a downturn or a crisis. That being said, any low-interest-rate phase should not be allowed to persist and, once an upturn sets in, action should be taken to swiftly and rigorously tighten monetary policy again.

You stand pretty much alone in adopting this stance. Most central banks rely on lending regulation as their preferred means of combatting overheating.

The two approaches are not mutually exclusive. Such macroprudential measures, as they are known, should be the first line of defence against bubbles. These instruments, which include ceilings on mortgaging, are a more targeted tool than interest rate hikes. But let’s be perfectly honest here. No detailed experience has been gathered in this area and the jury is still out on the matter.

When you raise interest rates, this causes banks to run into difficulties ...

... especially when banks haven’t done their homework. When interest rates remain low for a prolonged period of time, this can impose pressure on the banks. If their short-term refinancing costs then rise sharply and quickly, the problems they face might even intensify if these banks have previously granted long-term loans at low interest rates for overly long periods. This eats away at their profits, making it more difficult for them to accumulate equity capital and weakening their resilience. But that is something which the banks, first and foremost, need to accept and take on board; monetary policy cannot mop up such mistakes when, say, a tighter monetary policy stance becomes necessary.

The ECB justifies its zero interest rate policy with the goal of low inflation. Why is it incapable of pushing up inflation to its target level of just under two per cent?

Who says we are failing to do this? Though we have not yet achieved our goal, we are nonetheless on the right road. Getting to the finishing line takes time in the aftermath of a financial crisis. Many governments, enterprises and households are deep in debt. Their first priority is to reduce the size of this debt. Banks, too, need to tidy up their balance sheets. This all puts a brake on aggregate demand, as well as on inflation. Above and beyond this, it will take time until previous levels of competitiveness have been reached again on all sides. This, too, has the effect of dampening price pressures. But such phenomena should be of a temporary nature.

There are also longer-term price-dampening factors to consider, such as globalisation. Would it not be better to reduce the inflation target?

No. Studies of the optimal inflation rate do not, in my view, contradict the ECB Governing Council’s definition of price stability. We should therefore retain the definition. If we change our inflation target, we will face the threat of price expectations becoming unanchored, which would make life even more difficult for us as a central bank. It would damage our credibility. We did not increase our inflation target during periods when inflation stood at over two per cent either, for good reason. This is why I take the opposing view to those who campaign for a higher inflation target with the aim of stimulating growth more strongly, or making government debt more sustainable through falling real interest rates, for example. I believe the price stability norm of just under two per cent to be appropriate, but it is geared to the medium term. This allows us to disregard temporary factors without losing credibility. 

If the factors weighing on inflation are of a temporary nature, you will have to tighten monetary policy once again at some point in the future. When will it be time to do so?

We are currently discussing the adjustment of our asset purchase programme in the Eurosystem. But even if we reduce net purchases, our balance sheet holdings continue to increase, and monetary policy remains expansionary. However, we would not be putting the pedal to the metal to the same degree as before. The ECB Governing Council has also made it clear that the policy rates will only increase once the asset purchases have ended. To this extent, then, the question of how much leeway monetary policymakers will still have when the next downturn comes is valid.

If the asset purchases continue, the Bundesbank will soon have more than a third of all German government bonds in its balance sheet, thus breaching the upper limit that the ECB has set itself.

We had good reasons for setting the upper limit. Mario Draghi explicitly referred to the legal aspects. We should now keep to this limit, otherwise purchasing risks will be amplified. Doubts could arise concerning member states’ own ability to access financing in the markets. Furthermore, the new rules adopted by governments for bond terms covering, for instance, any government bond restructuring could also be undermined as a result. If a central bank owned over a third of a country’s government bonds, it would have a blocking minority. Due to the prohibition of monetary financing, it would have to vote against debt relief, thus blocking a fresh fiscal start.

If the economic situation is poor, must the ECB then purchase more Italian bonds in order to stay within the 33 per cent limit for Federal bonds?

No. Incidentally, economic development seems to be taking something of an upward trajectory, from my point of view. We are expecting capacity utilisation to increase and price pressures to rise, opening up the possibility of a return to normal monetary policy.

What if this is not the case?

We have been pleasantly surprised of late, and I see no need to be pessimistic in this regard. But you can well imagine that even if the scenario were not as positive, it would not be in the Bundesbank’s interests for the ECB to deviate from the agreed capital key when distributing asset purchases, or to primarily purchase bonds from highly indebted countries with a lower credit rating.

France and Brussels are advocating the expansion of joint risk-sharing in the euro area. What consequences would this have for monetary policy?

We must focus our efforts on increasing growth potential, reducing unemployment and improving resilience in Europe, all of which would do a great deal of good for monetary policy. Structural reforms in the individual countries make the greatest contribution here. The political topics you are addressing must, from a central bank perspective, be assessed in terms of whether they ensure that the monetary union remains a union of stability.

In a liability union such as France is aspiring to, the ECB would have to deal with a powerful European ministry of finance.

A minister of finance would pose no problem for monetary policy per se, as any state with its own monetary policy will have a finance minister. What matters is how this is arranged. It is not even clear what functions a European minister of finance should have. Some envisage a fiscal policy taskmaster, whilst others see a generous redistributor of funds with a big budget. A role such as this must fit into the overall framework. There are, in essence, two possibilities for the euro area. The first would be to return to the Maastricht framework with its limitation of liability and its clear rules, but with extensive national sovereignty. However, the principle of governments’ and investors’ individual responsibility would then have to be reinforced. The second path would lead to a fiscal and political union, accompanied by a substantial transferral of sovereignty to the European level. This would require the EU treaties to be amended, a move for which I see no enthusiasm at present. Although I hear much talk of joint liability, there seems to be little conversation about joint decision-making and control.

To whom are you referring?

Those who want increased joint liability are less willing to give up sovereignty. This has already been evidenced by the treatment of the Stability and Growth Pact, which requires adherence to clear budgetary policy rules, but is repeatedly being breached – with reference being made, amongst other things, to national budgetary powers. No stable fiscal union can be established without a balance between actions and liability. It won’t work for long if one party orders and then leaves the others to foot the bill. 

In a fiscal union, northern European countries would have no majority for their stability policy views, as is the case on the ECB Governing Council.

The issue here is not northern versus southern European countries. When making joint institutional or Community decisions, you have to be able to deal with being outvoted. But for this reason I feel it is important for measures towards deeper integration to be embedded in a stability-oriented framework with reliable fiscal policy rules, for example. In any case, it is clear that we cannot expect long-term stability if there is a mismatch between actions and liability, if risk is shared and everyone carries on doing what they want.

Wouldn’t turning the euro area into a liability union play into the hands of anti-euro populists?

Policymakers will win people over to the idea of Europe particularly if they are able to clearly explain the benefits and offer a coherent package. A liability union without comprehensive treaty changes is not a part of that. So why don’t we first focus on joint projects that make tangible progress for society? Europe still lacks a common market for digital products. Securing external borders, the fight against terrorism, migration, development aid, environmental protection, and closing corporate tax loopholes also offer opportunities for real cooperation that could highlight the benefits of Europe.

A new government in Berlin could take a harder line regarding the euro. Could French President Macron put the idea of a fiscal union to rest?

Compartmentalised thinking like that is not helpful. The make-up of the governments in France and Germany has changed, and voters will soon be going to the polls in Italy, too. A number of important decisions are on the horizon – decisions regarding the framework of the currency union, regarding national reforms, and also, for example, regarding serious problems such as non-performing loans on banks’ balance sheets. Incidentally, there were no calls for a fiscal union in France. I also don’t believe that we’ll be seeing a fundamental shift in Germany’s euro policy any time soon.

Non-performing loans on banks’ balance sheets are threatening to become a permanent problem.

Non-performing loans tie up banks’ equity capital and create a great deal of uncertainty if the right precautions aren’t taken. This means that banks are more reluctant to grant loans to dynamic enterprises and, overall, it slows down structural change and stable economic growth. However, banking supervisors in the euro area have recognised this problem and are calling for the balance sheets to be cleansed more swiftly.

In order to write down non-performing loans, banks need more equity capital and more profit. Low interest rates are hindering this.

As a central bank, it’s not our job to adjust our interest rate policy so that banks generate enough profits. Incidentally, low interest rates support economic activity, allowing banks to lower their risk provisions ...

... but you can’t just look on as your zero interest rate policy destroys banks’ business models ...

... I don’t agree with that assessment. Parts of the banking system have structural problems, business models need to be adapted, and consolidation in the banking sector will continue. The low-interest-rate environment is an additional burden and may accelerate this process. Financially sound banks, however, are also capable of dealing with low interest rates, especially as the interest-rate environment is already changing again.

How great are the risks to financial stability posed by shadow banks, i.e. hedge funds, investment funds and other investment vehicles?

Supervisory authorities are currently working on gaining a more accurate picture of the shadow banking sector and its dangers for financial stability. Then they can assess whether it needs to be more strictly regulated. The concern is that systemic risks could arise from shadow banks. But this is not something that only affects Europe – in recent years, the shadow banking sector has seen especially rapid growth in China.

Is China threatened by financial crisis?

Property prices and debt in China have risen considerably. For this reason, developments in the country are being monitored very closely. If China were to actually experience a crisis, it would certainly leave its mark on the world economy and on Germany. However, China certainly has enough leeway in terms of fiscal, monetary and economic policy to stabilise its economy in the event of a crisis.

German exporters have profited from the boom in China. Our large trade surpluses are causing concern not only for Donald Trump. Do you also believe that Germany exports too much?

No. Our large trade surplus is not a consequence of currency manipulation or targeted measures in economic policy, as some may claim. Instead, it is the result of many microeconomic decisions made under free market conditions. It also reflects the appeal of German products. Furthermore, it means that we are building up savings in relation to foreign countries, which is to be expected with an ageing population. It is my assumption that the recent, very large current account surpluses will shrink over time. We can also support this by improving the framework conditions for investment in Germany. However, I think it would be absurd to want to combat these surpluses by resorting to trade restrictions or similar dirigiste means.

Savers in Germany are being punished. Inflation is higher than nominal interest rates.

Accommodative monetary policy is having a negative impact on interest income, and I understand the concerns of savers. However, there have previously been regular periods of negative real interest rates, too. Currently, long-term interest rates are especially low. At the same time, though, building loans and loans to enterprises are cheap, and monetary policy is bolstering the labour market and domestic demand. Ultimately, a stability-oriented monetary policy must be geared towards its mandate of price stability. Low interest rates won’t go on indefinitely either.

Many people perceive the current situation as financial repression. Are central banks deliberately suppressing interest rates in order to clear government debts?

No. Price development is at the focus of our monetary policy decisions. If price pressures rise, then we have to tighten our monetary policy.

Will you immediately abandon the easy-money policy when inflation rises?

In that case, central banks mustn’t hesitate in normalising monetary policy. We can’t take any consideration of government financing burdens during the normalisation process.

With all due respect to your principle of stability, do you believe that, even with this stance, you have a chance of succeeding Mario Draghi at the helm of the ECB?

Mario Draghi’s term of office doesn’t end for another two years. Any discussion about his successor is both premature and detrimental to the office.

However, it is often said that Germany would have to make concessions in policy matters if a German were to become ECB president.

I think it would be disconcerting and highly problematic for the acceptance of the currency union if, from the outset, people from particular countries were barred from occupying top positions, or if this was tied to certain conditions. Nobody had this discussion about the Netherlands, France or Italy when their nationals were made head of the ECB. Candidates for important offices should be chosen on the basis of ability, not nationality.

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In conversation

Dr Jens Weidmann

Interview with Jens Weidmann,
President of the Deutsche Bundesbank

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