“Unsound government finances are a risk” Interview published in "Welt am Sonntag"

Interview with Jens Weidmann conducted by Anja Ettel, Olaf Gersemann and Holger Zschäpitz
Translation: Deutsche Bundesbank

Germany has just reported shock inflation of 3.8% – its highest rate since 1993. Do you remember how high the policy rates were back then? 

Naturally, they were considerably higher. But the situation back then was fundamentally different. 

At that time, Germany was in the middle of a reunification boom, so the situation wasn’t exactly normal, either. 

Precisely. But with the crucial difference that the economy then was booming, whilst inflation was already high and threatening to rise further. For that reason, the Bundesbank temporarily increased the policy rates to over 8%. Today we find ourselves in a completely different situation. In spite of the strong recovery, we still haven’t completely overcome the most severe recession of post-war times. We’re emerging from years of weak price pressure. And there’s no question of shock inflation. It was foreseeable that a series of one-off factors would drive inflation upwards temporarily. Chief among them was the discontinuation of the VAT reduction. Thus, inflation may rise towards 5% in the short term by the end of the year before falling again substantially. 

The ECB has made it clear that it doesn’t intend to change anything with regard to the extremely low interest rates and asset purchases. Can you understand that the general public here is very unsettled by that?

We have to be vigilant and keep a close eye on developments. But you mustn’t forget that the ECB Governing Council doesn’t just set monetary policy for Germany, but for the euro area as a whole. While Germany contributes just over one-quarter of euro area inflation, price pressures in the rest of the euro area are currently considerably lower than they are here. The ECB has to take that into account and cannot focus on individual countries. The ECB Governing Council has also said that it will tighten its stance once the price outlook for the euro area in the future is clearly above 2%. 

But you surely don’t intend to ignore the millions of Germans who may have taken out a life insurance policy to provide for their old age or have stashed money away on their bank accounts and now have to watch as their purchasing power dwindles.

Low interest rates are making safe investments less attractive and I can see why people are dissatisfied. But the purpose of the low rates is to help us fulfil our statutory mandate of ensuring price stability. We have undershot our target for some time now, and current projections show that this is likely to be the case over the next few years, too. Our aim is to meet this target again safely and sustainably. We should not be pressured into pursuing other aims such as guaranteeing minimum returns on certain types of investment or fixing the solvency problems of governments.

The question is whether you will ever manage to get away from extremely low interest rates. In Italy, there are already open calls for the ECB to step in and assist with government financing. 

The EU treaties explicitly prohibit central banks from financing governments. What matters to me is that we normalise monetary policy again in good time when the inflation outlook calls for it. We need to keep a close eye on whether price pressures do actually weaken as expected in our forecasts. I wouldn’t rule out higher inflation rates, either.

The ECB is anticipating inflation of 1.4% in 2023. Are you saying it could get worse than this? 

Uncertainty is exceedingly high at the moment. On the one hand, price pressures have been fairly weak over the last few years even when economic conditions were upbeat, and the pandemic is still an economic risk. On the other hand, the bottlenecks that we are seeing in many sectors at the moment could lead to higher prices. Consumer spending that was pent up during the pandemic could also unleash stronger demand than we are currently anticipating. And if this results in higher inflation expectations and wages, a price surge that was only temporary to begin with could continue, thus increasing inflation in the medium term, too. That’s exactly why, at the meeting of the Governing Council, I advised against committing to a very expansionary stance for too long. 

You were outvoted. Is the ECB Governing Council failing to recognise a potential danger?

No, but many of my colleagues weighted these risks differently. Moreover, Christine Lagarde has made it clear that the ECB Governing Council can make adjustments at any time – in both directions. In any event, I will strongly recommend keeping a close eye on the risk of an inflation rate that is too high and not only on the risk of one that is too low. 

But deflation could be a positive thing, if digitalisation makes products such as mobile phones cheaper and cheaper.

Of course, the prices of individual products can also fall significantly, and that’s not actually a problem. But if prices decrease across the board, we run the risk of a harmful downward spiral. By the way, digitalisation doesn’t necessarily mean that prices will constantly fall. For instance, powerful internet platforms are being established which could one day potentially dictate prices because competition is dwindling. Climate policy will also produce sustained inflationary pressure. For example, our calculations suggest that the price path for carbon approved by the Federal Government will, by itself, raise the inflation rate in Germany by an average of around 0.2 percentage point per year.

Doesn't debt also drive inflation in the long term?

Unsound government finances are a risk, as we have seen all too often. That’s why monetary policy must not become harnessed to fiscal policy. As I said before, the ECB is not there to ensure the solvency of governments. We also need reliable fiscal rules which really are binding. As soon as the pandemic has been overcome, it must be ensured that the very high government debt ratios subside again. 

Your defence of the Stability Pact has made you something of an isolated figure now, even in Germany. Sentiment has turned towards a looser spending policy

I don’t feel so isolated in that regard, actually. Something we can all agree on is that the pandemic was an extraordinary situation. Large-scale fiscal countermeasures were justified in this case. After all, the escape clauses in the fiscal rules are designed for precisely these types of scenario. It’s also acceptable to discuss readjusting these rules here and there. But it would be wrong to maintain the exceptions once the emergency is over, or to question the fiscal rules in general. Rules with enough clout to reliably curb the increase in debt are essential.

Yet the threat of a potential clash with fiscal policymakers is looming. Is the ECB equipped to handle that? 

The law grants central banks in the euro area a high degree of independence so they can focus on their primary objective of price stability. On this basis, we need to make it clear time and again that we will tighten monetary policy when the inflation outlook calls for it. We cannot make allowances for how this will then affect governments’ financing costs. Euro area governments have recently issued bonds with longer maturities. Taken by itself, this buys them more time until an interest rate hike has an impact on the budget. However, the central banks’ extensive bond holdings run counter to this, meaning that increases in the interest rates will once again have a larger impact on government finances. 

Do the other central bankers in the Council also feel that the ECB cannot act with consideration for fiscal policy when inflation gets out of hand?

There should be no doubt about that – otherwise the ECB Governing Council would not be fulfilling its task. 

The ECB Governing Council recently set out a new strategy. One of its aims was to communicate more clearly. Do you really believe this was successful? 

Economic relationships are complex, uncertainty about future developments can be high, and decisions are indeed often compromises. In these cases, a somewhat more nuanced explanation is necessary. But the wording of our target has become clearer and simpler. Previously, it was unclear what “below, but close to 2%” could mean exactly, which led to speculation about the point at which a lower inflation rate was no longer tolerable for the ECB Governing Council. The new target of 2% is quite a bit clearer.

Even there it’s unclear whether the ECB should step in at 1.9% inflation or whether 2.5% would still be acceptable, as some of your colleagues in the Governing Council are already hinting at.  

Of course, the new strategy still has to be put into practice over time, and it is also normal that not everyone on the ECB Governing Council interprets the individual elements of the strategy in exactly the same way. In any case, we have agreed on a symmetrical target of 2%, so upward or downward deviations are equally undesirable. This serves to firmly anchor inflation expectations. This means that we should also hit the lower bound more rarely and resort to unconventional measures and emergency programmes less often. What is important is that we scale back these measures again as soon as the situation has normalised.   

That’s precisely the problem. How do you expect to ever discontinue asset purchases amid such conflicting interests?

The Pandemic Emergency Purchase Programme, or PEPP, must be brought to an end once the crisis is over. After all, the first P stands for pandemic, not permanent. It’s a question of credibility. Our other purchase programme, the APP, is intended to support price developments. This will likewise be discontinued as soon as the price outlook allows it.

Is an interest rate reversal conceivable as long as the asset purchase programme is still running?

I assume that net purchases will be stopped first, and then interest rates will be raised – this is not least because asset purchases have significant side effects. The order would then be: first, we will end the PEPP, then the APP will be scaled back, and then we can raise interest rates.

It doesn’t sound as though German savers can count on interest rates increasing any time soon. When will that change?  

As I said, when the price outlook allows it, interest rates will go up. But I can’t give you an exact date.

Many economists are saying that they don’t expect any meaningful interest rates until the end of the decade. 

Nobody can say for certain when that will be. The pandemic has shown how quickly things can change unexpectedly. Personally, I expect that there will be a sustained pick-up in inflationary pressures in the years to come and that we will then see higher interest rates. 

What should German savers do until then?

This depends on what they are saving for, their investment horizon and their appetite for risk. It is still the case that that if you want to realise higher returns, you have to accept greater risk. However, as a matter of principle, I don’t provide recommendations for any specific investments.

Tell us at least how Germany’s most senior central banker invests his own money, and what percentage is invested in equities. 

I personally have been investing part of my savings in shares for a long time now. Specifically, I regularly invest in index funds in order to spread my investments widely and to avoid any potential conflicts of interest. 

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