“The trough is likely to be behind us now” Interview with Jens Weidmann in the Frankfurter Allgemeine Sonntagszeitung.
Interview with Jens Weidmann conducted by Patrick Bernau, Gerald Braunberger and Georg Meck.
Translation: Deutsche Bundesbank
Mr Weidmann, how bad is the crisis going to be? When will we have come through the worst of it?
Over the past few months, we have experienced the sharpest economic slump in the history of the Federal Republic of Germany. Economic output is sure to have fallen much more steeply in the second quarter than in the first. The good news is that the trough is likely to be behind us now, and things are picking up again. But the steep slump will only be followed by a comparatively gradual recovery.
So the rescue policy is working? Have policymakers done the right thing?
Yes. In the midst of a difficult situation, policymakers reacted quickly and with determination to protect businesses and employees. That was the right thing to do. The Federal Government’s latest decisions are now giving the economy a strong boost. This should also create confidence: for consumers to purchase and for firms to invest. It is important that the problems do not eat away at the economy too much. Plenty has been done to prevent this.
And if, as some fear, the big wave of bankruptcies bears down on us in the autumn, will policymakers have to up the ante?
Right from the outset, it was clear that future developments would be difficult to predict and that we would probably have to repeatedly readjust our response. The faster we beat the pandemic, the lower the risk of the economic crisis becoming entrenched or even intensifying. We must prevent temporary difficulties from becoming permanent problems. Businesses that are fundamentally healthy should not fail. That was why swift action was needed. The German government certainly still has scope to provide further support if necessary.
The main measure in the economic stimulus package is the temporary VAT reduction. Is this a suitable way of boosting the economy?
Yes, absolutely. The tax cut aids the economy, because it is passed on to customers, strengthens consumers’ purchasing power and stimulates spending, and because businesses are able to keep more of their earnings, which will help them to regain their footing amidst a difficult situation. It is important that the measures are targeted and temporary. That way, the burden on government budgets will also be no more than temporary, and deficits will subsequently diminish.
Isn’t there a danger that the government will become accustomed to the high level of borrowing, especially as it seems to cost nothing thanks to the zero interest rate?
That danger does indeed exist. You quickly get used to the large sums that are now being bandied about. This makes it all the more important to remember that our sound public finances are a crucial condition for a strong government that is capable of acting. That is why we are able to put up a strong defence against the crisis now. But afterwards, it will be vital for us to return to a sound budget.
In the crisis, the state is setting itself up as a business concern: the Federal Government is investing in the long-established German carrier Lufthansa, as well as in the vaccine start-up Curevac. And nobody is kicking up a fuss.
I would distinguish between two things here. On the one hand, it is right that the government is providing not just liquidity but also capital in order to prevent the collapse of businesses that are fundamentally healthy …
So it should not only provide injections of cash or grant loans but also provide large sums in the form of state ownerships in individual cases.
… at the same time, however, it does bother me to see calls for industrial policy interventions becoming more popular. This should not be the standard for normal times. After all, aggressive industrial policy and government investment are not what put the German economy in such a good overall position before the crisis. Rather, its good conditions as a place to do business, such as motivated, highly skilled employees and an efficient system of government, are what set Germany apart. Competition is the best precondition for innovative, prosperous firms – and for allowing consumers and employees to share in greater prosperity.
Will the government also have to bail out banks again? How stable will the financial sector be if more and more loans start to default?
Unlike in the financial crisis, banks are currently playing a stabilising role. They have significantly expanded their lending to enterprises – partly thanks to government loan guarantees. But the same warning applies here – the longer the crisis lasts, the greater the risks to bank balance sheets.
Could this cause some banks to fold?
The fact that supervisors and regulators learnt important lessons from the financial crisis is paying off now. This has put banks on a much more stable footing and given them a fairly comfortable capital base. And firms, too, have larger capital buffers. Moreover, politicians are currently taking extensive measures to support the economy. In view of all this, I am also optimistic regarding banks.
How worried are you that the prices of some goods are rising quickly at the moment? Are we facing inflation?
The prices of many food products, such as meat, fruit and vegetables, have indeed risen considerably. But just think about how cheap petrol has become. Basically, there are two countervailing effects in this crisis. If less is being produced, because businesses have been ordered to shut down or because global supply chains have been disrupted, this tends to drive up prices. At the same time, consumers are staying at home more, and we are seeing a drop in demand in some areas, such as clothing. This, of course, has the effect of lowering prices.
And which effect is stronger?
Overall, the price-dampening effects are probably stronger, especially as energy prices have fallen so sharply. In Germany, moreover, the VAT cut is likely to play an important role in the second half of the year. Next year, the return to the old tax rate should then bring the inflation rate up. All in all, though, there is a great deal of uncertainty going forward here, too.
The European Central Bank (ECB) has once again launched a huge asset purchase programme, the PEPP, as a result of COVID-19. Was that really necessary?
In this crisis situation, I believe creating a strong monetary policy stimulus was the right thing to do. When deciding on the new purchase programme, it was particularly important to me that it be temporary and clearly linked to the crisis. At the same time, it has greater flexibility than the ongoing programme, the PSPP. We had in-depth discussions about these features in the Governing Council of the ECB. One thing we all agreed on was that a monetary policy response was needed. Yet there will always have to be a weighing-up of the scope of the programme and the degree of flexibility, which is no easy task. In this regard, I am certainly more cautious than others.
How great is the risk that the programme will become entrenched and billions will still be flowing long past the end of the immediate crisis?
We monetary policymakers, too, must ensure that we promptly change course so that we do not overshoot the target. For us, everything has to hinge on the price outlook, which right now is highly uncertain. This very issue was one of the facets of our discussion. How long do we continue on the same course? How long will it bind us, and what problems will that cause? As you know, I consider government bond purchases to be a special monetary policy instrument; in using them, we must never lose sight of the risk of monetary policy being harnessed to fiscal policy. It needs to be clear that when it comes time for monetary policy normalisation in terms of price developments, there can be no avoiding it out of consideration for the government borrowing costs.
De facto, the ECB is already flattening yield spreads between government bonds of different credit ratings with its purchase programme. Risk is no longer being priced.
The programmes are not flattening yield spreads completely, but they are reducing them. There is undisputedly a general expansionary monetary policy stimulus. However, in my view, we are treading a fine line, especially when making selective purchases – whether of government or of corporate bonds. What is important to me is that bond purchases should not ultimately undo the capital markets’ steering function.
Your Austrian colleague, Robert Holzmann, has gone one step further and has ventured that the ECB could also start to buy shares.
I do not wish to speculate on all the things that could happen in hypothetical scenarios. Monetary policy has now taken a very proactive role, and we should be careful that we ourselves do not further fuel the markets’ expectations of monetary policy.
Could you explain what you mean?
Heightened expectations could put us under pressure in our next decisions. If we then cannot, or do not wish to, deliver what is expected of us, the stock market will respond with displeasure, which may in turn result in calls for monetary policy action. We should not let ourselves be painted into a corner like this.
Is that to say the point has been reached at which you say: “Enough is enough. Buying shares is not a monetary policy tool. Leave us out of this!”?
For me, the point has been reached at which we should stop speculating.
Not only the ECB, but many other central banks around the world are also deploying their full firepower, with the US Fed leading the way. Are you comfortable seeing all dams breaking and monetary policy having to enter the fray in every crisis?
You are addressing a topic that has been on my mind for some time now. Our mandate as central bankers is quite clearly price stability. That is what we must be measured against. This does mean that we must act in a crisis – after all, crises have an impact on inflation. However, monetary policy isn’t a panacea. At present, for instance, the onus is on fiscal policy. It is in the first line of defence against the consequences of the pandemic, it has the necessary democratic legitimacy and it also possesses suitable tools. It can, for example, address households’ and firms’ financial problems. It can decide under what circumstances transfer payments should be made or loans granted – including between states.
Can we let the crisis be a reason to change the European architecture – as is the case with the reconstruction fund proposed by Brussels? Should the EU be allowed to borrow to fund it?
I personally believe that European solidarity – which includes financial solidarity – is the right course of action in such a crisis. Nor does the European architecture stand in its way. I furthermore believe that the EU budget, which has always been a tool for redistribution, is a suitable means of achieving it. By contrast, I am of the opinion that large-scale, long-term joint borrowing would shift the basic framework and its balance. Such a step would therefore require a more comprehensive move towards integration in order to ensure a balance between joint liability and joint action. However, it does not look as though there is currently a willingness to go down this route. Debt should consequently be clearly limited and rapidly repaid. Otherwise, we risk ever increasing pressure for more EU borrowing.
Brussels would then have created a perpetual motion machine: the EU borrows, the ECB buys the bonds that have been issued without any chance of escape.
No perpetual motion machine exists in physics – nor is there anything comparable in economics. The European Treaties prohibit us from financing governments for good reasons. We need to ensure that we have “guardrails” that protect us. Moreover, we must not succumb to a debt illusion: just because debt is incurred at the European level and does not appear in national statistics, does not mean that it has disappeared. At the end of the day, debt has to be serviced and repaid by the taxpayer.
Borrowing has never been as sexy as it is today. In the crisis, even serious people are saying that there are no limits to government borrowing. The proverbially frugal Swabian housewife doesn’t stand a chance.
The image of the Swabian housewife is often misconstrued. She does not put money aside as an end in itself, but in order to spend it on something useful and also to tide her over in bad times. This is exactly the case we have here. It made sense to ensure sound finances in normal times. And it makes just as much sense to use this financial leeway now that times are bad in order to be able to take decisive action to turn things around.
However, the Swabian housewife and all other savers should not expect interest rates to rise anytime soon.
The sooner we overcome the crisis, the sooner higher interest rates can be put back on the agenda. However, this is likely to take some time, and the new normal is also likely to be lower than what we were previously used to. Globally, we are dealing with a long-term trend towards low interest rates, for which there are various structural reasons. In terms of price developments, monetary policy is currently certainly a factor behind the particularly low interest rates.
What exactly do you mean by structural reasons?
The natural interest rate, as it is called, has fallen steadily over the past 30 years. This is due to ageing societies, amongst other things, but also to declining productivity growth. At least as far as the latter is concerned, a wise economic policy has a positive impact. Higher economic growth means higher interest rates in the long run.
The Federal Constitutional Court has put a spoke in the wheels of the European Court of Justice in spectacular fashion. Were you surprised by the ruling in May?
Well, it was clear for some time that there was a simmering conflict between the Federal Constitutional Court and the European Court of Justice. This conflict has now broken out in this case.
The Federal Constitutional Court in Karlsruhe has set a deadline of three months for the ECB to comply with its demands. Otherwise, the Bundesbank may no longer participate in the public sector purchase program, or PSPP. How are you dealing with this situation?
From the Federal Constitutional Court’s point of view, there is no evidence that the monetary policy objectives pursued with the PSPP have been weighed against the associated economic and fiscal policy effects. The court’s main concern is therefore that the Governing Council of the ECB should carry out such an assessment in a transparent manner and that the result should not be manifestly disproportionate. We regularly discuss the suitability, impact and side effects of monetary policy measures within the Governing Council of the ECB. In this debate, individual members may, incidentally, well come to different conclusions.
Do you, too, think that there is a lack of transparency?
By international standards, the ECB is a very transparent central bank. There are press conferences with the President of the ECB, public accounts of the meetings, numerous speeches and interviews, hearings in the European Parliament and a wide range of publications. In addition, our strategy review involves a discussion on ways in which we can become even more transparent in order to better explain monetary policy to the broader public, in particular.
This process is continuing despite the coronavirus pandemic, although it will take a little longer. As regards the ruling, I, for one, am confident that we will find a way of clarifying the proportionality considerations. This will enable the Bundestag and the German Federal Government to fulfil the responsibility conferred upon them by the court.
How are we to imagine that playing out in practice? ECB President Christine Lagarde is hardly going to appear before the Bundestag to account for the institution’s actions.
No, but there are various other possibilities ...
Are you going to be sent in as messenger? The ECB is doing everything it can to demonstrate that it is not bound by the rulings of national courts.
It is a question of doing justice to the ruling by the Federal Constitutional Court whilst at the same time also upholding the independence of the ECB and the Bundesbank. And I do not see any contradiction there. After all, accountability and independence are two sides of the same coin anyway. What we are seeking is an appropriate way of making the deliberations of the ECB Governing Council plainly accessible to the Federal Government and the Bundestag. I am convinced that we will succeed in good time.
Will you report to the Bundestag in future and testify before parliament on monetary policy?
Even before now, I have always enjoyed being in a dialogue with the committees of the Bundestag. It’s important to exchange views and knowledge in this way, and it is easily compatible with the independence of monetary policy. I will, of course, uphold the confidentiality of the ECB Governing Council meetings. I would therefore be delighted if the Bundestag were to take the initiative and invite me back for more dialogue.
It is a delicate position for you, given that you may find yourself having to justify decisions made by the Governing Council of the ECB that you yourself voted against.
Once again: the Federal Constitutional Court expects an explanation of the ECB Governing Council’s deliberations, and the outcome must not be manifestly disproportionate. But that also means that the Governing Council has discretion in its decision-making and that not all members have to have voted in favour of all decisions. There’s no conflict there, and I will do my part.
Are you concerned that the Karlsruhe ruling and the public debate being called for will ramp up pressure on monetary policy to pursue other objectives aside from exclusively price stability?
As I see it, the nub of the ruling lies precisely in drawing a clearer distinction between monetary policy and economic policy. I believe that is an important distinction to make, as I think monetary policy certainly is in danger of being overwhelmed with an ever-growing list of new desires and objectives.
The Constitutional Court has fundamental doubts about government bond purchases and is therefore calling for strict limits.
There are limits that spring from the European treaties. And, of course, monetary policy is bound by these; for instance, by the ban on monetary financing of governments. From my perspective, it is important that monetary policy keeps sufficiently clear of this ban – for its own credibility, public confidence and its ability to effectively safeguard price stability.
How much of a risk is there, do you think, that this ongoing policy of cheap money will generate bubbles? Real estate prices have soared, equities have seen some serious movement – fuelled by central banks all over the world.
Central banks must take action whenever they perceive a threat to their objective of price stability, and the crisis called for even greater monetary policy accommodation. This is also bolstering asset prices. If problematic excesses occur, intervention will – first and foremost –need to come from other policy areas, such as macroprudential policy. Nonetheless, it is also clear that monetary policy must not give the impression that it kicks out investors as soon as a crisis is on the cards and then is too tentative in its tightening of the reins afterwards. Those kinds of expectations and an overly cautious monetary policy response were contributing factors in the financial crisis. This highly accommodative monetary policy must not become the default setting.
And who will end up footing the bill for the crisis? Who will be shouldering the costs of the hundreds of billions in rescue and recovery funding? Are we all going to be a little poorer?
The pandemic is placing pressure on all of us. It is making the entire world poorer. The very point of spending billions in emergency funding is to contain that damage. I mean, water damage caused by fire hoses and renovation costs are no reason not to call the fire brigade when there’s a fire. What would have happened if there had been no policy response and no central bank action? I am convinced that an unchecked crisis, an unchecked economic slump with all of its associated amplification effects, would have turned out to be a lot more painful and costly for all of us.
Isn’t the state carving out a role for itself as the sole source of salvation?
Of course, the state will have to take a step back again in the future. But now is the time when it must step up to the plate: in this extraordinary situation that we find ourselves in, the state is akin to a backstop. It is taking on risks and burdens weighing on businesses and households because these are better shouldered by the community.
Nevertheless, at the end of the day, someone will have to bear the costs of the huge debts being run up. There are already calls from the left to ask the wealthy to foot some of the bill. What’s your take on that?
Debts have to be repaid and the debt ratio has to be brought back down. It is too early to tell for certain at this stage what this will necessitate in terms of consolidation. It’s also going to depend on the strength of future growth. In a social market economy, it is a general rule that the broader shoulders tend to make the greater contribution. This fundamental principle is not going to change, and it is up to policymakers to decide how that will work in practice. However, when doing so, they will need to bear in mind the feedback effects that the tax system has on economic growth. In the case of Germany, I am not anticipating that the debt ratio will climb by such an extent as to render extraordinary fiscal measures necessary. The situation might be more complicated in other countries with higher debt levels.
That’s a reference to the situation in Italy.
No, I am not talking about any country specifically. At the end of the day, the important thing is that all countries restore their government finances to a solid footing. In the current situation, European solidarity and support are important. However, the heavy lifting will still have to be accomplished at the national level. How that is done is a matter for each country to decide for itself, and that again is a question of national solidarity.
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