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“I can well understand that savers are unhappy”

“I can well understand that savers are unhappy” Interview in der Frankfurter Allgemeinen Sonntagszeitung

19.08.2018 | Jens Weidmann

Interview with Jens Weidmann in the Frankfurter Allgemeine Sonntagszeitung.

Mr Weidmann, since the 1970s, Germany’s economy has gone through three major phases. The Great Inflation was followed by the Great Moderation, which gave way, ten years ago, to the Great Recession. Which of these eras is your favourite?

Most of all, I prefer living in the here and now. From an economic vantage point, each of those phases presented its own distinct challenges.

Has today’s era already been given a label?

At any rate, there is no disputing that the recession has been consigned to history. Germany’s economy is booming. unemployment is at a low and employment is steadily on the increase. And the euro area, too, is now enjoying a broad upswing and dwindling unemployment.

So everything’s hunky-dory.

I’m afraid not. Look beyond the sound economy and low interest rates and you’ll see what are still excessively high levels of government debt in many countries and a surfeit of non-performing loans dragging on banks’ balance sheets. Trend growth rates are persistently weak, and joblessness in some European countries is still too high. So there are still a lot of unresolved items on the agenda.

Imagine we were now facing a crisis like the one which struck in the summer of 2008 – do you think we would notice the danger sooner than we did back then?

Forecasting crises isn’t any easier today than it was in those days. I dare say that a different set of risks would catch us by surprise. What it all boils down to is that we need resilient economies and financial systems. Then we will be better equipped to withstand disruptions, whether they are unexpected or not.

September marks the tenth anniversary since Lehman Brothers collapsed, which was when the financial crisis came to a head. In retrospect, do we really know what went wrong back then?

It was the combined effect of a whole bunch of factors which caused the crisis to flare up. There is no one straightforward explanation for what happened. There were excesses, regulatory gaps and misaligned incentives in the financial system. Risks were misinterpreted and mispriced. The crisis had its epicentre in the US real estate market, but the shock waves rippled around the globe after the bubble there burst. Overall, systemic resilience was too low.

The lessons learned …

… are multi-faceted: increase the transparency surrounding risks, respond sooner to unsound developments, boost the resilience of financial systems, economies and sovereigns – and, last but not least, take credible steps to boost individual accountability so that investors can take adequate account of risks or choose not to take on the exposure in the first place.

Many banks which up until the crisis had generated respectable profits ended up being hauled out the abyss by the taxpayer. But in 2008 it was decided to let Lehman Brothers go bust. Looking back, was that a mistake?

The crucial errors had surely been made beforehand. In retrospect, perhaps it would have been better to rescue Lehman. But it's easy to be wise after the event. And would that have prevented the crisis from happening, or would it have meant that a different domino would have toppled first? The wrong takeaway, in any case, would be to conclude that market mechanisms such as a bank insolvency need to be eliminated. Quite the opposite: bankruptcies need to be possible going forward, but less risky.

Did Lehman Brothers represent the pinnacle of the crisis?

No, but the Lehman episode opened a new chapter in the crisis. To date, 2009 was the only year in which global economic activity receded; the World Bank has been calculating these data since back into the 1960s. In the euro area, the malaise was compounded in 2010 by the onset of the sovereign debt crisis.

How are the financial crisis and the euro crisis related?

In the euro area, the financial system and government finances were already getting out of hand when the crisis flared up. Some economies had got out of kilter, one factor being the deep current account deficits caused by a loss of competitiveness. The financial and economic crisis brought these problems to the surface and intensified them. Feedback loops came to the fore. In one direction, unsound public finances placed a strain on banking systems which held huge stocks of those countries’ government bonds. In the other, the support given to banks added to the burden on government finances.

What would you say did most to salvage the situation? The fiscal assistance programmes, perhaps, or the European Central Bank’s monetary policy?

External assistance and policy accommodation might help ease the symptoms and thus win a little time, but they’re not a long-term course of treatment. It is the member states themselves that need to deliver the all-important contribution by getting their public finances in order, cleaning up banks’ balance sheets, and strengthening the forces of growth and competitiveness, to name but three.

Do you see a possibility that the ongoing currency crisis in Turkey might engulf the entire financial world, just like the sub-prime crisis did ten years ago?

The Turkish economy is in a very perilous state, but let’s not forget that it accounts for just 1% of global GDP. Yet at the same time, there is a real risk that contagion might ripple out, potentially unleashing direct effects via credit relationships and foreign trade channels, to name but two. The exposure is manageable for Germany’s banking sector, plus the financial systems have been made more resilient overall. And in terms of exports, Turkey ranks as Germany’s sixteenth most-important trading partner, behind countries like Hungary and Russia. What is far more difficult to estimate are the indirect effects, such as a general loss of confidence which might then take its toll on other emerging market economies. However the situation unfolds, these developments make it crystal-clear that the best way to stave off crises is to run sound and responsible economic and fiscal policies and to have an independent stability-oriented monetary policy.

If sound public finances and competitiveness are crucial, as you say, then there are many countries – Italy and Greece, say – which are anything but healthy these days. Government debt levels there are as high as ever. Has the medication they have been given to ease the pain merely prolonged their affliction?

There's a risk of that, absolutely. And that’s a point I've been making over and over again. Recently, especially, it would appear that the eagerness to embrace reform in some quarters has flagged. But the steps that need to be taken won’t get any easier when interest rates start to climb again or the economy takes a turn for the worse. We need every country to have competitive economic structures and robust government finances. That's the name of the game. At the end of the day, the euro area member states own their economic and fiscal policies, and that's something they always hold very dear.

To put it more bluntly, would you say that the rescue measures were ultimately counterproductive?

The reason why they were rolled out was to prevent matters from spiralling downwards and to ease adjustment processes. But there is a potential downside, which is that urgent action might get kicked into the long grass. What matters to me as a central banker is that monetary policy does not become harnessed to fiscal policy. You don’t need me to tell you that I take a critical view of the Eurosystem providing support, such as targeted government bond purchases, when individual member states encounter fiscal emergencies. The current asset purchase programme, on the other hand, is broadly based and has a different rationale. But it has nonetheless led to a situation where central banks are now the euro area countries’ biggest creditors. It’s quite a problem, in my eyes, to see monetary policy move so close towards the fiscal policy sphere. And what is more, monetary policy should not become some kind of insurance cover for speculators.

What do you mean by that, exactly?

Monetary policy needs to make sure it operates symmetrically. Before the crisis, it was often the case that, because bubbles are difficult to identify, monetary policymakers only responded after a bubble had burst, but when they did so, their response was very accommodative in order to keep the damage in check. For financial market agents, this asymmetric monetary policy acted as a kind of insurance policy and undoubtedly helped fuel the crisis. It distorted incentives: income was pocketed while the job of mopping up the mess was left to the central bank.

And what would be a symmetric response?

A symmetric response would be to rapidly loosen monetary policy in a downturn and, by the same token, to rigorously tighten up the reins again when the economy picks up and the financial markets are booming. And to do all these things while never losing sight of the goal of monetary stability.

The ECB isn’t really proceeding rapidly and rigorously right now. It has stated that it will carry on purchasing new government bonds until the end of the year, and policy rates are not expected to be hiked before mid-2019 – even though the economy is in rude health.

What's crucial for me is that, following the latest decisions, monetary policy will be normalised in the foreseeable future. The pace of what comes next is a matter we discuss on the ECB Governing Council. And it's only natural to have quite different views on this topic.

Yes, but the inflation rate in the euro area is now already at 2.1%, which is clearly higher than the ECB’s professed target of “below, but close to, 2%”.

The current rate of inflation is being driven predominantly by energy prices – domestic price pressures are still perceptibly weaker. There is, in any case, very little our monetary policy measures can do to influence inflation in the short run, and this is why we have deliberately made our price stability objective a forward-looking, medium-term target. Judging by the June forecasts, annual inflation will run at 1.7% through to 2020. If you ask me, that is certainly consistent with our price stability goal. And that is why the time has come to reduce the degree of monetary policy accommodation – especially so given the side effects of loose monetary policy.

German savers don’t make such nuanced distinctions – all they can see is that a zero rate of interest and 2% inflation is eating into the real value of their assets.

It is right to say that interest rates are very low right now and that real interest rates have turned negative even in longer maturity segments. But as monetary policy returns to normal, interest rates will pick up again. As things stand today, it will be a gradual process that takes some time. In the United States, yields on 10-year Treasuries are already close to 3%. We’re still playing catch-up in the euro area on that score.

But my retirement kitty is in free-fall today.

I can well understand that savers are unhappy about the low interest rates, but you build up your retirement provisions over several decades, and that does put the current interest rate situation into perspective somewhat. Another thing is that we have certainly had spells of negative real interest rates in the past. And remember, too, that a portfolio of financial assets is normally made up of different components. There will be older bonds that still generate respectable returns, equities, life insurance policies and bank deposits. Over a long period, the average portfolio was still producing a decent return overall, and is continuing to do so in the current spell of low interest rates. But the real rate of return on that kind of portfolio turned negative at the beginning of the year. This topic is discussed in detail in the Bundesbank’s latest Monthly Report, which will be published tomorrow.

And why did that happen?

It mainly has to do with equity market prices, which since the beginning of this year have no longer been rising like they did last year, but have been more or less treading water.

We can already hear the Alternative for Germany party claiming that Draghi and Weidmann are destroying our retirement savings and creating poverty in old age.

Sweeping accusations like that are preposterous. Political pressure – no matter what quarter it comes from – should never stop us from fulfilling our mandate to preserve price stability. That’s why, as monetary policymakers, we are free from political influence.

But surely poorer people are bearing the brunt because they have fewer stocks and shares, or perhaps even none at all, in their piggy banks.

True. Wealthier households are more invested in equities, and share prices have soared over the past years. That said, less wealthy households benefit from a monetary policy stimulus if it amplifies the upswing and creates more jobs and higher wages. It also boosts the growth rate of pensions, which for many is the most important part of their retirement provisions. For indebted households, low interest rates are a source of relief. That’s another factor to consider when gauging the impact of low interest rates.

Those are all repercussions of the financial crisis and the countermeasures it prompted. Will the “non-standard” monetary policy, as it is known, we have been seeing in recent years increasingly become the “new normal”?

That isn't the approach I would take, not least in light of the special characteristics of the euro area. For one thing, government bond purchases are often a major component of non-standard policymaking, but in a monetary union, they take on a different character.  We've got 19 separate national fiscal policies, and the member states have committed to a no-bail out rule. The problems this raises are something we have already discussed, of course. If you ask me, the United States, the UK or Japan aren’t suitable templates.

Are you pledging that the ECB will soon return to the path of virtue as trodden by the Deutsche Bundesbank?

The ECB is not the Bundesbank, and the euro area as we know it today calls for some topics to be approached differently than Germany did before monetary union was launched. Also, the experiences of the crisis will leave their mark on monetary policy. That said, the rules-based and consistent anti-inflationary stance which was the bedrock of monetary policy at the Bundesbank is something I regard to this day as a crucially important asset.

Will there ever come a time when the ECB and the national central banks have offloaded all the government and corporate bonds they have accumulated? How realistic is that?

I am a proponent of running down the stocks of assets again in future when the outlook for inflation is amenable. Quite apart from my fundamental concerns surrounding the use of government bond purchases as a regular monetary policy instrument, this should be in the interests of its supporters, especially, given the need to have accommodative latitude again to combat future crises – latitude which wouldn’t exist if we had largely exhausted the scope we have in this regard.

Perilous risks are still lurking on your balance sheets, with nigh on €1 trillion in claims against the Eurosystem. How dangerous are these TARGET balances, as they are known, for the German general public?

Huge numbers like that naturally attract a great deal of attention and also concern. But the highly polarised debate that has emerged risks crowding out a sober analysis of the matter in hand. First of all, TARGET2 is a platform for settling payments in the euro area. TARGET balances, as they are called, arise when central bank liquidity flows from one country to another. Before the crisis, these balances attracted little attention.

And after that?

In the first few years of the crisis, the rising TARGET balances then became an indicator of tension in the banking sector, as some banks saw risk premiums for wholesale funding increase and central bank loans take the place of private capital. This caused outflows of capital away from non-resident investors in the countries in question, creating negative TARGET balances or amplifying existing ones. When the tension eased, the balances declined. They have been increasing again since 2015, but for different reasons. The main driver is the large-scale asset purchases by central banks, which are pushing central bank liquidity into the system across all the member states. However, this liquidity then flows to Frankfurt or Luxembourg, say, where international banks have their liquidity management operations.

That sounds harmless. But I’m afraid I still haven’t quite understood what you’re saying.

The TARGET balances have to do with the fact that national central banks continue to exist following the establishment of the ECB, and that monetary policy is conducted and accounted for as part of a decentralised framework. Imagine if the Banco de España purchased a Spanish government bond from a US bank which holds an account with the Bundesbank in Frankfurt where it keeps its deposits. This transaction would see the liquidity generated by the asset purchase flow from Spain to Germany, creating a positive balance at the Bundesbank and a negative one at the Banco de España.

Any more examples?

Trading activity can also cause TARGET balances to build up. Let's say someone in Italy buys a German car. When the delivery is paid for, liquidity is transferred from Italy to Germany. Before the crisis, there were more cross-border loans in the banking system, which caused return flows of liquidity and kept the TARGET balances low. What I think matters is that the debate surrounding the TARGET balances doesn’t get to the heart of the monetary policy risks.

Why is that?

Let’s hypothesise for a moment. Say we had a monetary policy that was accounted for centrally at the ECB. If, starting tomorrow, it were decided to recognise the provision of liquidity via the ECB, rather than via the national central banks as hitherto, the TARGET balances would vanish into thin air. But the risks would still be there.

How come?

Additional central bank money is created when the central banks grant loans to solvent banks in return for collateral or, say, purchase government bonds. The questions this poses are as follows. Is the collateral adequate? Are the banks sufficiently solvent? Are the sovereigns whose bonds are being purchased of a high-enough credit quality? This is the essence of the monetary policy risks.

If that were the case, then the TARGET balances which economists are currently debating with such intensity would be more a symptom of the problem – one that distracts from the underlying problem and the risks it involves?

The balances can point to the existence of problems, but they are not their root cause. That’s why I think it would be misguided to see the solution to any manner of problems in tackling the TARGET balances. Simply capping the balances, for example, would be a disproportionate constraint on the free movement of capital which, after all, is a materially important component and asset of the euro area.

Yes, but Germany’s balance nearly adds up to a €1 trillion.

Germany’s positive TARGET balance is presently somewhere in the region of €900 billion. Besides the liquidity within the cashless payment system – the deposits with the central bank – currency is another source of liquidity. For instance, Germans like to pay in cash, and that is why outflows via the Bundesbank are above-average in volume. These outflows create liabilities to the ECB. If we look at the Bundesbank’s net claims on the ECB – that is, currency and TARGET together – at last count they came not to the frequently cited one trillion number but to somewhere around €530 billion. That's still 16% of GDP, admittedly, but there were also instances at the peak of the crisis when the figure spiked above the 20% mark.

That still sounds dangerous. If a country – Italy, say – were to leave the euro area, would Germany then be left nursing its claims?

The repayment obligation would continue to exist, even in this hypothetical case. That's a point that ECB President Mario Draghi has also made clear.

It may well be that the country in question can no longer honour this obligation because it has devalued its own currency but the claims are still denominated in euro.

If you ask me, hypothetical losses like that are unlikely to materialise. And even if they did, they would ultimately be allocated across all the central banks in the Eurosystem according to each one’s share in the ECB's capital. What I’m saying is that our positive TARGET balance doesn’t constitute any particular risk in this regard. A country with an even TARGET balance would not be better off, quite simply because the losses would be distributed according to the ECB's capital key.

But it's safe to say that a country like Italy would potentially present a substantial threat: “If you don’t help us, we’ll quit the euro and leave you nursing huge losses.”

It’s hard to believe that a politician acting in the best interests of their country would entertain such fanciful thoughts. In my view, leaving the euro risks wreaking severe damage, particularly on the country that decides to leave, and on its savers, for example.

So you're saying that the economists calling for a TARGET cap are, in reality, out to kill off the euro?

No, and insinuations like that don’t help anybody. I’ll say it again – we certainly do need to talk about the risks involved in monetary policy. The TARGET balances can serve as an indicator of these risks, but there's no guarantee that they do. They will recede when a normalisation of monetary policy crimps central bank liquidity and the private capital market returns as a major channel for offsetting interbank exposures.

Would you say that preserving the euro is an objective for monetary policy?

Monetary policymakers have a mandate to preserve price stability in the euro area. That's the specific and material contribution which the Eurosystem makes to preserving the euro. Responsibility for decisions on the composition of the euro area lies in the political sphere at the European level and in the member states. And over the long run, only politicians can guarantee that the member states’ economies will perform in a way that keeps the euro area functioning as a union of stability.

Over the past years, you yourself have gone against the majority view on the ECB Governing Council over major decisions such as the government bond purchase programme. What is it like to be in such a minority position?

I advocate positions because I believe them to be right. And that’s why I don’t see any problem in having a controversial debate. Incidentally, even in a minority position, it is possible to exert an influence over individual decisions, such as the design of the current government bond purchase programme. In addition, the ECB Governing Council takes many monetary policy decisions by consensus – like its most recent one, for example.

Mario Draghi’s term of office comes to an end next year. Many expect you to be his successor. The southern European countries fear that an ECB with President Jens Weidmann at the helm would subject them more than ever to the diktat of ultra-orthodox monetary policymaking.

That the ECB has just one objective, and that is to keep prices stable. And that's something that the peoples of Europe need to be able to count on, no matter who presides over the ECB.

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