“Inflation is a greedy beast.” Interview with “Der Spiegel”
The interview was conducted by Tim Bartz.
Mr Nagel, do you run marathons?
No, I very much enjoy playing tennis. Why do you ask?
Because you say that in the fight against inflation, the “home stretch” can be the hardest – in other words, that final phase before the 2% inflation target that the European Central Bank (ECB) is aiming for is achieved.
I think it’s a good analogy. We can see the objective gradually coming into view: inflation is falling. But we also know that it has not yet been achieved and that inflation could quickly rise again. Just like when you’re on the home stretch, it is now a matter of gritting our teeth and persevering.
Businesses and consumers are longing for a cut in interest rates, and the pressure on the ECB is great. At 4.5%, the main refinancing operations rate is now well above euro area inflation of 2.9%.
Falling inflation shows that our monetary policy is working. But inflation has not been tamed. The fact that it is now falling so rapidly also has to do with lower energy prices and base effects.
You will need to elaborate.
When it comes to inflation, we look at the year-on-year rate. Prices were very high in October 2022. The rise from that level was therefore comparatively small in October 2023. This arithmetical effect will soon dissipate. As a result, the inflation rate could go back up a little in the coming months.
The Federal Government wants to raise VAT on gas and district heating back to 19%. Is this a mistake that will fuel inflation?
This will cause the German inflation rate to rise only marginally. And I am always in favour of ending crisis measures as soon as a situation eases.
What other factors could cause inflation to rebound?
Energy prices, first and foremost, in view of the war in the Middle East. Moreover, goods and services inflation is generally still high. Wages and profits could also see stronger growth than expected. We will have to wait for the data that will be available to us at the next meeting of the Governing Council in December.
It is hard to believe that the ECB makes spur-of-the-moment decisions based on data. ECB President Christine Lagarde is already predicting that key interest rates will remain as high for the next few quarters as they are now. How do these two statements fit together?
In saying what she said, she is keeping unrealistic expectations in check. Interest rates need to stay high for long enough to bring the inflation rate to back to 2%. This is what we are working towards in the ECB Governing Council.
... as in the body on which you also have a seat as the President of the Bundesbank. Do you think Ms Lagarde’s caution is justified?
Our latest forecast now shows that inflation is unlikely to come close to 2% again until sometime in 2025.
Investors and many economists are expecting the first interest rate cut to come in the summer of 2024. Are they all wrong?
Not all bets pay off. There is considerable uncertainty as to how the situation will develop. At the moment, we still cannot be sure that interest rates have reached their peak. It is too early to speculate on lower interest rates.
Firms have begun offering their employees double-digit wage increases. Are we experiencing a wage-price spiral?
What you are referring to are often catch-up effects caused by high inflation. After all, real wages – by which I mean wages adjusted for inflation – have fallen very sharply, dropping by more than 4% in 2022 alone. It is understandable that these real wage losses should be offset. I do not see a self-perpetuating spiral at present, though. What’s important is that inflation expectations are kept anchored. Because everyone being convinced that prices will remain stable would be best for wage bargainers.
According to the textbooks, a central bank needs to raise interest rates as soon as the economy starts overheating and prices therefore begin to rise. Put simply, nothing is overheating in Europe. The upward pressure on prices is largely being caused by the energy markets. So what are the interest rate hikes actually accomplishing?
A great deal. Energy markets play an important role in inflation, but they are actually holding it back at the moment. For other goods and services, meanwhile, inflation has become entrenched. We can see that the interest rate hikes are helping to lower inflation. This is because they dampen demand by making it more expensive to borrow and more attractive to save. Typically, the effect on demand comes before the effect on prices. In 2024, the interest rate hikes will push inflation down even further, of that I am sure.
In that case, you could lower the key interest rates next year.
In order to combat high inflation, interest rates must first remain high. But I do believe we will have overcome the current dip in growth in 2024, assuming the conflict in the Middle East doesn’t escalate. I don’t see any signs of a hard landing or a recession with a knock-on effect on the labour market.
The ECB first completely underestimated inflation and then frantically raised interest rates at breakneck speed. What makes you so sure that you won’t be wrong again?
Our models have their limits in terms of the kind of historical structural breaks we have seen in recent years. Forecasting models, including our own, were not especially well suited to this exceptional situation. But we have learned from this.
Do you at least have better models now?
We are constantly developing our models. In times of great uncertainty, as in the pandemic, it is also helpful to simulate different scenarios. We compare the various results and expand our range of models, increasingly to include artificial intelligence. However, our experts’ knowhow remains an important factor.
ECB chief economist Philip Lane, in particular, initially failed to pick up on inflation. Why hasn’t he lost his job?
All members of the ECB Governing Council, myself included, had to rethink the situation in monetary policy terms after Russia started its war of aggression. For me, the most important thing is that we keep learning. And would we have had the backing to raise interest rates so quickly and so significantly at the beginning of 2022?
Inflation is widening the social divide. Poorer people, in particular, suffer because, by comparison, they spend a larger share of their income on consumption. Moreover, they usually have no savings and do not benefit from rising asset prices. This implies that the government should provide more assistance, which, in turn, would fuel inflation. A vicious circle?
Not if the aid is targeted. And as regards one of the main culprits – energy prices – these are down again and this is easing the burden on the public. Either way, I believe that there must be incentives to use energy sparingly. That goes for everyone, rich or poor.
Not for energy-intensive enterprises. The government wants to grant them generous relief from electricity tax. Where does that leave low earners?
Our mandate as a central bank is to combat high inflation. And this also helps precisely those who have little to make ends meet – the hardest hit by inflation.
Where do you feel that everything is becoming more and more expensive in your own life?
My weekly shop, of course. Your readers will say that Mr Nagel can’t complain, not with his pay cheque. And it is true that not everyone can cope so easily.
Do you hunt for deals in the supermarket?
Of course. I always keep an eye out, especially when it comes to food because I like cooking. And I have also noticed that some things are now getting cheaper again. A box of ten eggs has often been 30 cents cheaper of late; the price of butter has also come down.
What do you think of the “greedflation” theory – i.e. that enterprises are using inflation as an excuse to excessively raise prices in order to up their profits?
Inflation itself is a greedy beast. It eats into the economy, devouring income and savings. As far as enterprises are concerned: profit margins have risen significantly overall. However, developments vary considerably from sector to sector. I’m quite sure that some prices were raised a little more generously, especially at the start of inflation. However, competition works well, especially in the case of food, as demonstrated by discounters’ price wars.
Is your salary adjusted for inflation?
No, my salary is not adjusted for inflation. It is adjusted in line with changes in the salaries paid to Federal civil servants.
In future, you are going to be working twice as hard; three out of six positions on the Bundesbank’s Executive Board will be vacant at the beginning of 2024. Central and state governments are not making any progress in nominating successors. How annoying is that for you?
The Bundesbank is fully operational. However, we have many important tasks, and vacancies should be filled quickly. I would very much welcome a timely decision on the board positions from politicians.
You have said that Germany is not the sick man of Europe. What makes you so sure about that?
In the English-speaking world, in particular, I often hear that Germany is teetering on the brink. But I see things quite differently. The German economy has coped better with the energy crisis than had been feared. It is now a question of addressing the longer-term challenges, especially the green transformation of the economy and digitalisation. German firms have always dealt successfully with new and difficult situations. We are not the sick man of Europe. But we must avoid becoming so.
Our position in terms of taxes, labour costs, productivity, human capital and infrastructure has deteriorated considerably. Is Germany underperforming?
We are facing major challenges: not just transformation and digitalisation, but also demographic change and a shortage of skilled workers. For instance, the labour market has dried up in some cases. But the German economy has shown time and again how well it can adapt. And policymakers have every opportunity to enhance Germany’s framework conditions. For example, the labour market should be made more flexible and open. There is a great deal to do.
What exactly do you mean?
Things like speeding up the integration of skilled workers from abroad, for example.
In just a few years’ time, the pool of available workers will probably be smaller. This is hampering our growth prospects. We need sufficient skilled workers in Germany to ensure our prosperity.
Given the tasks presented by the energy transition, armament, immigration, housing construction and digitalisation, are you in favour of abolishing the debt brake?
Definitely not. Budgetary rules are important in order to limit government debt. The debt brake has helped to ensure that our public finances are sound. And that is a key basis for economic growth – and ultimately for stable prices, too.
So do you welcome the recent ruling by the Federal Constitutional Court prohibiting the government from putting the funds earmarked for combating the COVID-19 crisis towards climate protection?
I welcome the fact that the ruling significantly strengthens the binding effect of the debt brake. It is now better equipped to ensure sound public finances again. The numerous special funds have diminished transparency and weakened the debt brake. That said, the ruling is not a decision against certain measures.
Is it actually possible to integrate all €300 billion worth of shadow budgets into the normal budget whilst also investing in housing construction, digitalisation, climate change mitigation and armament, complying with the debt brake and not fuelling inflation?
It is ultimately up to policymakers to ensure that funding measures are in place for key items of expenditure. Even reforms to the debt brake are not out of the question. We at the Bundesbank have made proposals to this effect. If debt ratios are low, the credit framework could be expanded moderately and investment could be better protected, too. Germany’s Basic Law must be amended for reforms to take place. If the debt brake is seen as too restrictive, this would certainly be the right way forward.
How worried are you about a new debt crisis in Europe? Italy’s debt costs, reflected in its government bond yields, are higher on average than they have been for quite some time, at 4.5%. Confidence in the country appears to be declining.
As a matter of principle, I don’t comment on individual euro area countries. It goes without saying that the euro area relies on sound public finances. Otherwise, we are tilting at windmills when it comes to ensuring price stability. The ECB must ensure that its monetary policy measures are effective. But fiscal policymakers need to step in if a country is on an unsound footing and the response from the capital markets sends bond yields soaring.
Can the euro be politically instrumentalised? Extreme parties in many countries are calling European cohesion into question.
Maybe they should look at the facts and compare the inflation rates of the euro with those of the Deutsche Mark. Over the past 24 years, inflation has averaged just under 2% in the euro area. In the twenty years prior to that, by contrast, inflation in Germany with the Deutsche Mark was just under 3%. Mythologising isn’t helpful. The environment was certainly different in the past. But we can be proud of what monetary union has achieved over the past few decades. And this despite the global financial crisis and pandemic.
Many people do not understand how monetary policy works and how everything is connected. Populist parties are exploiting this. Does that bother you?
We have to use good arguments and facts to tackle what are sometimes dangerous messages. It isn’t easy, I am realistic about that. In the past, we have all too often been content with communicating with the markets – often using specialist jargon. We want to express ourselves more clearly and engage with people. That is a big challenge.
The ECB has been buying bonds issued by European countries for years. It has thus made it easier for governments to take on debt. Now the ECB’s balance sheet is hugely inflated and it has to get rid of the bonds again. How difficult will this be?
Before the pandemic, inflation was too low for years. The bond purchases were aimed at counteracting this rather than making it easier to take on debt. Things are now moving in the other direction: we are gradually reducing our bond holdings. And with regard to the balance sheet, its size has fallen by €1,700 billion within 12 months. But we can do more.
ECB chief economist Philip Lane seems to be infatuated with the idea of keeping the crisis policy in place. He wants the central bank to continue holding large volumes of government bonds and to support commercial banks by providing them with liquidity. What’s your view on this?
What is important is that we in the Governing Council of the ECB agree that a tight monetary policy is necessary. And today we are seeing it having its intended effect. Inflation is declining. I cannot yet tell you what our monetary policy toolkit and our balance sheet will look like in future. Generally speaking, I would have a preference for significantly smaller central bank balance sheets. If necessary, these would give us more room for manoeuvre in our monetary policy.
The Bundesbank currently has to pay commercial banks 4% interest on their excess reserves – a good deal for the institutions and risk-free to boot. At the same time, the Bundesbank holds €900 billion in German government bonds, which generate virtually no interest. In short, you are facing huge losses. Which headline do you fear more: “Bundesbank bankrupt”? Or: “Government forced to rescue Bundesbank with fresh capital”?
Neither. The Bundesbank’s balance sheet is sound. We have considerable assets. And the financial burdens will pass, which means that the Bundesbank will make profits again at a later stage and will be able to use these to offset losses. That is why I do not foresee these scenarios emerging. We need to do a good job of explaining this, as we did in the 1970s, and we are able to do that. This is a situation we can deal with.
Back then, we carried forward our losses and then offset these loss carryforwards with profits in later years. It is clear that we will not be able to distribute profits to the finance minister for an extended period of time. But he has known that for a long while.
You could take more money from commercial banks. To date, they have only had to deposit 1% of their customer deposits with the Bundesbank as minimum reserves, which is a type of deposit that does not earn any interest. They collect plenty of interest on their other deposits. Discussions are now underway to increase the non-interest-bearing minimum reserves above 1%. That would be good for the Bundesbank’s bottom line, but the banking industry is putting up resistance. Rightly so?
It is not our profit and loss account that concerns me here. That is a monetary policy instrument. The non-interest-bearing minimum reserves support the Eurosystem’s tight monetary policy stance, which is dampening lending and thus contributing to price stability.
But the institutions are up in arms because they are afraid of losing risk-free profits. Are you going to take on this fight?
This is not a fight. This is responsible monetary policy. And that is ultimately also in the interests of banks.
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