“It would be counterproductive, economically speaking, to ease the restrictions too soon” Interview with Rheinische Post

The interview was conducted by Moritz Döbler and Kerstin Münstermann.
Translation: Deutsche Bundesbank

Dr Weidmann, Germany is in the grips of a hard lockdown as it struggles to fend off the second wave of COVID-19. Do you think we can actually afford the large-scale crisis measures, like the Federal Minister of Finance tells us?

Weidmann: The numbers we’re talking about here are formidable, and for some, they’re daunting. But it was right to take determined action to prevent the economy from falling into a downward spiral. Germany ran a tight ship when times were good, which is why it has wiggle room now that times are bad. The heavy government borrowing is bringing stability to the economy and in so doing preventing the situation from deteriorating.

But is that debt still manageable?

We expect the debt burden to be smaller than it was during the great financial crisis and to be sustainable for the German government. In fact, the government even has a little more room to fine-tune its borrowing, should it need to do so. You see, uncertainty surrounding the pandemic and its fallout for the economy is still acute, and it could swing in both directions. For example, the second COVID-19 wave is stronger than anticipated, and there are reports that a new, more contagious variant of the virus has emerged. On the other hand, vaccines have now been rolled out more quickly than initial projections had indicated.

With a backdrop like this, is robust forecasting still even feasible?

But of course. That said, the intense uncertainty makes it more important to continue to be frank about the assumptions such forecasts are based on, such as regarding future infection rates. We saw over the summer how quickly the economy can rebound after a lockdown. That’s why the second wave hasn’t prompted us to fundamentally call into question the forecast we presented in early December.

But won’t the second wave inflict far more damage?

That’s not what I am currently expecting. Economic activity is not being restricted quite as much as it was in the spring. Businesses are now more adept at coping with the situation. And vaccinations are going to be rolled out shortly. Infection rates are what matter most of all. It’s crucial to keep the virus in check and ultimately overcome it if the economy is to make a lasting recovery.

Some parts of the economy, such as Germany’s automotive industry, were already facing pressure without the added impact of coronavirus. Would you say the pandemic and structural change will make us the “sick man of Europe” again?

I wouldn’t underestimate the transformative and innovative capabilities of the German economy. And industry has come through the crisis relatively unscathed so far – the physical distancing requirements have taken more of a toll on services. The key challenge for policymakers now is to support the economy while not impeding structural change. In any case, it’s undeniable that the government crisis-response measures will have to be discontinued once the crisis is over.

Before or after the next election?

Crisis measures shouldn’t depend on election dates, but rather on how the pandemic evolves and its impact on society.

Do you see a danger that policymakers might be tempted to extend short-time working benefits for too long?

Surely most people don’t welcome short-time working arrangements and would much rather work their usual hours. Short-time work is a standard instrument, and expanding it temporarily is the right move at this point in time. It’s a way to bridge the severe economic slump and prevent unemployment rates from ballooning. But once the worst is behind us, the special arrangements for short-time working benefits will need to be lifted. Otherwise, there’s a risk they might hinder the necessary structural changes. Timing these moves is a difficult balancing act, and I don’t envy the politicians who have to make decisions like this.

The ECB has modified its policy stance three times in all: in March, in June and most recently in November. You have been critical of the latest assistance measures, arguing that the share of euro area government bonds held by central banks should not be allowed to get too large and that the emergency monetary policy measures should not become a permanent fixture. Does this mean you think the ECB is providing too much assistance?

The monetary policy options are limited right now. When, for example, restaurants and shops are closed, no one is able to spend any money there, even if interest rates happen to be low. This is where government – fiscal policy – needs to step in to help businesses and employees cushion their losses in income. The main way in which central banks can help is by making sure that funding conditions remain favourable and preventing a credit crunch that would exacerbate the crisis. Otherwise, inflation would shift even further away from our target, jeopardising price stability. So while I consider monetary policy support necessary, I certainly have my doubts about the scale of the new asset purchases the Governing Council has agreed upon. What’s also important is that these measures need to be wound down again once the emergency situation they were designed to alleviate comes to an end.

Would you say politicians are overly reliant on central banks?

I think you’ll agree that politicians have acted appropriately, by and large, during this crisis, but they shouldn’t get used to the idea that central banks will keep interest rates low forever. If the price outlook necessitates a reversal in policy rates, then that is what should happen.

But can we seriously expect to see a reversal in interest rates in the next few years?

Our latest forecasts indicate that euro area inflation will probably remain on the subdued side over the next few years. Consequently, it might take some time before interest rates turn around. 

Do you fear for central bank independence? You’ll be aware of the intense pressure the Fed in the United States is already facing …

In most cases, central bank independence is enshrined in law. Within the Eurosystem, we have a clear mandate to focus primarily on ensuring price stability. That ought to be sufficient to withstand the kind of pressure the US Fed is coming under.

Ought to be?

We shouldn’t encourage people to expect too much of us. If governments believe that central banks can always be counted on to rush to the rescue, they might think there are no longer any bounds to government borrowing. That higher debt then turns up the pressure on us. And that is why we have to make it very clear, over and over again, that we will turn a blind eye to government borrowing costs if price stability necessitates higher interest rates. It should be in a government’s own interest to ready itself for a hike in interest rates, instead of pretending it can easily afford any debt burden, no matter how large.

In your view, how dangerous is it for morale that the negative interest rates have enabled the Finance Minister to rake in billions of euro on all the fresh debt he is issuing?

Two points spring to mind here. First, the German government has committed itself to keeping public finances in good shape and it is also duty-bound to do so by the country’s constitution. Second, it is currently benefiting from very low, indeed even negative, interest rates. Together, these two factors give the German government the fiscal firepower to push back decisively against the crisis. But no one, be they in Germany or any other euro area country, should count on interest rates staying this low for good. It is certainly highly unusual that Greece and Italy can borrow for less than the United States at the moment. 

How concerned are you about price stability?

Price measurements aren’t giving us the complete picture right now. You see, some of the goods included in the price index can’t be purchased at all and one or the other service can’t be used. I’m talking about things like package holidays and visits to restaurants or theatres. So the question surrounding future inflation is whether deferred consumption will be made up for at a later date. Whatever happens, I expect to see brisker inflation once the containment measures have been lifted. Another factor in Germany is that the VAT rate will go back to 19%. In Germany, inflation rates could lie above 2% in the second half of the year. In the euro area as a whole, however, the general price trend will remain broadly on the subdued side.

Did the VAT cut make sense?

I did think it made sense at the time, and I am still not quite as sceptical as others on this score. Around 60% of the tax cut was passed though via lower prices, which meant it had a positive impact on consumer purchasing power. The other 40% hasn’t gone to waste, though, because it stayed within the corporate sector, where it has shored up distressed enterprises. That helped, too, even if the crisis most likely didn’t affect all businesses to the same degree. The cut in VAT rates served the additional purpose of accelerating consumption as a means of smoothing the economic cycle. But that doesn’t usually work on a lasting basis, which is why it is right to reverse the VAT cut as scheduled at the end of the year. 

What needs to come next once the lockdown is over? Should we gradually ease off again or would it make more sense to keep things tight?

First and foremost, it’s public health and human lives that are at stake here. As for the economic outlook, it all boils down to the infection rates at the end of the day. So it would be counterproductive, economically speaking, to ease the restrictions too soon. If people fear for their health, their uncertainty and reluctance to consume will take its toll on the economy. What matters is that the efforts to contain infection rates have the intended effect.

Is enough trust still being placed in market forces? The vaccine did originate in the private sector, after all  ...

Government has an important role to play. It is right for government to assume additional risks and stabilise the economy in a time of crisis. But it would be wrong to think the public sector now plays an entirely new role. You see, in our social market economy, government cannot take the place of competition in the private sector, nor of entrepreneurial innovation.

Is cash growing in importance because people have started putting money under their pillows again?

We observed an uptick in demand for cash at the onset of the crisis because people wanted to “play it safe”. At the same time, the pandemic has seen a spike in non-cash purchases. In any case, cash still has a rightful role to play as a means of payment. It protects privacy and is not as reliant on technical infrastructure.

Education is particularly important for economic growth. What needs to happen so that young people growing up in the shadows of COVID-19 don’t fall behind over the long run?

I consider this to be an important topic. In many cases, learning from home has not made up for cancelled school lessons. Past experience with large-scale school closures indicates that the school pupils affected by closures were more likely to be unemployed and have lower incomes later in life. That should never happen again, and we need to compensate for lost learning. This might mean spending more on education whilst also embracing innovative approaches, of course, like making better use of digital media.

Has the threat posed by climate change been put on the backburner because of the pandemic?

That shouldn’t happen under any circumstances, and it hasn’t happened either, in my view. Climate change is one of the greatest challenges of our time, and it will have a critical impact on each and every one of us. Governments need to respond with effective measures. We can also play our part as central banks, for example by greening the financial system. We don’t make climate policy ourselves, though. There are a number of reasons for this. One is the considerable redistributive effects it involves, as the phasing-out of the use of coal is showing. That’s why climate policy is a matter for elected parliaments and governments.

In the United States, a new President will be taking office in January – what are your hopes?

I hope this means the divisions in US society can be overcome and that greater predictability will be restored in US policy toward the rest of the world. In particular, I hope that the World Trade Organization will enjoy a resurgence.

Do you see an end to the trade dispute with China?

The United States will carry on taking a critical view of China, and in some respects US criticism was warranted. But hopefully, the way the two countries deal with each other will change. That could help push back against protectionism, which is currently on the increase. It’s safe to say that taking a purely domestic perspective isn’t the best way forward in the United States or in China, and it certainly isn’t in Europe.

In your view, what things will have changed for good once the pandemic is over?

That remains unclear in many areas. However, the pandemic has undoubtedly given digital transformation a boost. Many people now have a clearer view of its benefits – but also of the things digitalisation cannot replace. In professional life, the idea of working from home has taken on new meaning. I dare say it will become more commonplace to split working hours into time spent working from home and being on work premises. For this offers significant benefits in terms of balancing family and professional commitments. That said, nothing can replace working in close proximity with one’s colleagues. Ultimately, we need to strike the right balance here.

What would you like for the new year?

I hope we quickly put the pandemic behind us and get back to interacting with others in a relaxed manner. Speaking for myself, that’s something I have sorely missed.

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