"Actors are keeping a cool head"
Interview published in Börsen-Zeitung
Interview with Joachim Wuermeling conducted by Mark Schrörs and Detlef Fechtner.
Translation: Deutsche Bundesbank
Mr Wuermeling, the financial markets are expecting the ECB to exit its ultra-accommodative monetary policy. Have the markets understood the ECB correctly?
Market participants had already begun last year to form expectations regarding monetary policy normalisation. Although, as one might expect, this involves a certain amount of volatility, actors are keeping a cool head. I see that as a positive development, one that also reflects the fact that the ECB Governing Council’s communication is being understood. I also believe that it is realistic for market players to expect that net purchases could expire by the end of the year and that the first interest rate hike cannot be expected to happen prior to the middle of next year.
But isn’t a clear announcement of the exit by the ECB lacking?
"The exit" is not a one-off event as such, but a gradual process. Thus, the monthly purchase volume under the QE programme has already been cut back to €30 billion. However, more importantly, communication has evolved. In the ECB Governing Council’s introductory statements at the beginning of its press conferences, the wording about the timing has been adapted to express growing optimism that the inflation rate will rise towards the price stability objective. According to the latest statement from last Thursday,
"The underlying strength of the euro area economy continues to support our confidence that inflation will converge towards our inflation aim of below, but close to, 2% over the medium term." The ECB Governing Council adds, however, that
"at the same time, measures of underlying inflation remain subdued and have yet to show convincing signs of a sustained upward trend".
Do you have any idea how to prepare the next baby steps – that is, to cap the direct link between net purchases under the QE programme and the achievement of the inflation target?
If you read the precise wording, then you will see that it is not about what has been achieved so much as the path taken towards reaching the inflation target – and thus about whether or not this path is seen as sustainable. Moreover, the latest communication has placed greater focus back on the entire monetary policy toolkit, especially the considerable holdings of assets acquired, the reinvestment of maturing assets and forward guidance regarding interest rates. Market participants have understood this very clearly, and particularly also the fact that the term "well past" used there does not mean simply a couple of weeks.
How specific must the ECB be in its forward guidance regarding the path of its policy rates?
In my opinion, the markets are not waiting for the Governing Council to set an exact time schedule for future interest rate moves. That would also violate the principle of monetary policy responding to changes in data and forecasts. However, they will certainly be expecting to receive information on the shape of the future path of interest rates in due course.
The question of the desired interrelationship between interest rate hikes and a future balance sheet contraction will come up sooner or later. Here is the example the United States has set: let’s first raise interest rates once or twice and then shrink our balance sheet. This approach does have some admirers on the ECB Governing Council. However, the conditions are different. Hence: can the US example be imitated?
I know that market participants often try to look two, three or even four years into the future. But please understand that I do not wish to speculate on issues which the ECB Governing Council has not even discussed yet and for which there is therefore no explicit communication. One thing is clear from the markets’ point of view: given the large size of the liquidity surplus, the deposit facility rate will, for quite some time to come, be the key benchmark for money market rates. This is why analysts are currently – and entirely justifiably – focusing on the deposit facility rate, as this will also be the benchmark that matters to the markets even after net asset purchases have been discontinued.
And how large should the balance sheet be in the long term?
This question is not even on the table right now. We are still in a phase of balance sheet expansion.
The longer the central bank remains a dominant purchaser in the markets, the greater the problem of distortion and of the market drying up becomes. If the central bank keeps on purchasing assets, wouldn’t it expose itself to this danger over the long term?
I do not see any drying-up of the market, but I see our purchases, of course, as having a – desired – impact on price formation. If net purchases expire this year, which, as is well known, the Bundesbank would be in favour of, we will not encounter a situation in which markets dry up and price formation is rendered impossible. By reinvesting maturing assets, we will subsequently maintain our market presence, but the volume will average around €15 billion and will only keep the volume of assets on our balance sheet constant rather than increasing it.
Your market operations are designed to hit an inflation target of below, but close to, 2%. In Germany, in particular, some people hold that price stability means 0% inflation.
Why, no. Even before the euro was introduced, central banks the world over – including the Bundesbank, in the days of the Deutsche Mark – were striving for inflation rates with a margin vis-à-vis the zero inflation bound. There are a number of good reasons for this. One is maintaining a sufficient distance from the zero lower bound for interest rates: deflation can lead to a dire downward spiral of falling prices, recession and unemployment. This we saw in the United States in the 1930s – but not only there. And that is why it is good to have a certain safety margin to guard against deflation. Rates of close to 2% are, as you are likely to hear at the railway station, a reasonable distance from the platform edge. Another phenomenon that deserves mention is that of "nominal rigidities". Whenever there is a general overall rise in prices, it is easier to adjust individual prices – including, for instance, wages – downwards in real terms in order to enhance competitiveness. This is because the amounts do not have to be reduced nominally but only kept stable over a relatively long period of time. Another factor is that, in the euro area, inflation rates are typically not the same across member states. The target has to be set such that even those countries whose inflation rate is below the euro area average are kept at a sufficiently safe distance from the zero inflation bound.
Is it your impression that the question as to the wisdom of the 2% inflation target has recently become more urgent? In the United States, in particular, central bankers are among those debating this topic hotly.
I think that the Eurosystem has given itself a sensible definition of price stability by aiming for a target rate of below, but close to, 2%. There is no reason, in my view, to call this policy into question. In the United States, where some have begun to talk of raising the target, I do not see a majority in favour of such a move. Nor, for that matter, would I broach the topic of a decrease in the target, and certainly not in an era in which the target has not been met. That would harm credibility and accountability – two properties which are of fundamental importance to central banks, in particular, if they are to fulfil their mandate of monetary stability.
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