Weidmann: Constitutional Court hasn’t given us a free pass Interview with the German business daily newspaper Börsenzeitung
Interview conducted by Mark Schrörs and Claus Döring.
Translation: Deutsche Bundesbank
Mr Weidmann, after the strong recovery over the summer, the euro area economy is losing momentum again, and the number of coronavirus cases is picking up markedly in many places. How concerned are you right now? Are we facing another recession, or even deflation?
Following the steep slump in the second quarter, the past few months have seen the economy grow at what might be a record pace, not to mention faster than expected. This was helped by bold fiscal and monetary policy action. However, a slowdown such as the one we are seeing now was to be expected. A swift return to pre-crisis levels is out of the question because of the continued restrictions on economic life. But the economic recovery is continuing nonetheless. And confidence in our baseline scenario has grown. This is good news in times of great uncertainty.
And the renewed rise in the infection rate won’t change that?
A certain resurgence in the infection rate would certainly be consistent with our forecast. As far as that is concerned, current developments are not yet encroaching on our baseline scenario. Not just that: these days, government, the economy and society are better positioned to deal with the pandemic. The measures that are now being rolled out to keep the virus in check are more targeted and confined to smaller geographical areas. But the current infection rates in the United States, say, or parts of Europe of course pose a risk to our forecast.
The €750 billion recovery fund is part of the “bold” response by EU fiscal policymakers. Yet disagreement has now emerged and the negotiations are dragging on. How dangerous is that? With the economy losing momentum, is it maybe even time for fiscal policymakers to go one step further?
I'll say it again. The economy has so far been recovering somewhat more quickly than expected. This means that there is no current need to up the ante on economic policy. Even so, no one can say for sure that circumstances won't evolve in a way that necessitates even more fiscal policy action in future. But that issue is entirely different from the question of what is happening with envisaged measures. Should the “Next Generation EU” recovery fund not materialise now, or should it materialise much later, this could trigger distinct market responses and cloud the economic outlook.
But when the fund is launched, might developments even turn out better still? The fund has not yet been properly incorporated into the latest ECB projections.
Yes. Our forecast can only incorporate those elements that are set in stone when it is prepared. Another measure it doesn’t include is the €100 billion in assistance being mobilised by the French government, for example. As such, developments in the euro area economy may turn out to be better than we assumed in the baseline scenario. However, it doesn’t just come down to the size of the stimulus packages; instead, it is particularly important that the funds are channelled into sensible, productive projects.
What level of risk does the euro’s recent appreciation pose to the economy?
I wouldn’t make too much of that. We shouldn’t look at euro movements in isolation from the factors driving them. The appreciation of the euro since the spring has been due to a more expansionary US monetary policy, but also to improved economic developments in the euro area and the positive signal sent out by the EU measures to combat the crisis.
So you do not share the concerns of some of your fellow ECB Governing Council members, and you see no need for action to address the strength of the euro?
It’s medium-term inflation that is decisive for monetary policy. Viewed in purely mechanistic terms, any appreciation will dampen inflation. But that view simply doesn’t show the full picture. We discussed this issue at our latest monetary policy meeting as well and ultimately reaffirmed our stance. At the moment, I see no reason to move away from our assessment. The monetary policy stance is appropriate at this time.
But there are some observers who argue that, in a once-in-a-century crisis such as the coronavirus crisis, it is better in monetary policy terms, too, to do too much in an emergency rather than too little.
It was right that we, the Eurosystem, responded decisively in the spring – in a situation characterised by extreme uncertainty – to prevent second-round effects from spilling over through the financial system. However, it does not follow that monetary policymakers need to up the ante the whole time, especially since fiscal policymakers’ precision toolkit is better calibrated to tackle this crisis and uncertainty has since diminished.
Yet market participants and economists are almost unanimous in their push for a further scaling-up and extension of the pandemic emergency purchase programme (PEPP). Would you sound a note of caution as far as these expectations are concerned?
I certainly would. I would caution against pre-empting decisions that are not yet on the agenda and first need to be discussed ...
... which almost sounds more like an appeal to your colleagues in the Governing Council than a recommendation to market players.
It is part and parcel of normal monetary policy operations for us to look closely at all the data on a regular basis, adjust our forecasts and assess whether we need to take action or not. And we demonstrated in the spring that we, the Eurosystem, are capable of acting. At the same time, however, we should not commit ourselves too soon or stir up expectations that we would then feel compelled to meet or even exceed. As regards the PEPP, we adopted it as a non-standard crisis response measure. This was clearly communicated, and the Governing Council should be reliable and consistent in this regard.
Initially, it was said that the main aim of the PEPP was to calm financial markets. In the meantime, it has become a second tool for influencing the inflation outlook alongside the regular asset purchase programme (APP). If the main objective right now is to tackle too-low inflation, would it not then be right to scale up the APP, together with the public sector purchase programme (PSPP), in an emergency rather than the PEPP?
To all intents and purposes, you’re right. Close to the lower bound, the APP is actually the purchase programme which the Governing Council uses to calibrate the monetary policy stance – the degree of accommodation. In my view, this is a distinction that is still worth making. Doing so is also important in view of the different rules in place. The characteristics we gave the PSPP were decisive factors in this programme being upheld by the German Federal Constitutional Court.
So you’re saying that if it's indeed the inflation outlook that counts, the APP would be your instrument of choice?
What I’m saying is that when the crisis is over, the PEPP should be terminated.
Some members of the Governing Council are calling for the greater flexibility built into the PEPP to be incorporated into the APP and PSPP. Would this usher in fresh legal problems between the ECB and Germany's Federal Constitutional Court?
I’m not a lawyer. All I can offer is my reading of the Federal Constitutional Court's ruling. What's clear to me is that the court did not give us a free pass. It found that the PSPP did not manifestly violate the prohibition of monetary financing thanks to the specific features and safeguards of the programme. If these boundaries were now blurred on a large scale, a legal problem might arise. The PEPP's flexibility has a great deal to do with its clearly limited purpose and restriction to the crisis period. And that is also why the PEPP must not become a permanent fixture.
The PEPP is a programme where the ECB is deviating from the capital key and providing some countries with more support than others. What is the difference between this and monetary financing?
Government bond purchases are not monetary financing per se. And deviating temporarily from the capital key does not yet automatically constitute an obvious breach of this prohibition under EU law. The Governing Council’s current policy is that the PEPP will ultimately have to be brought back into line with the capital key. What’s more, the Federal Constitutional Court has made it clear that what counts is the overall assessment of the features and the economic context in which the respective programme was adopted and which it is geared towards. And this context is quite simply a different one for the PEPP than it is for the PSPP.
Interest rates are another lever that can be operated alongside the bond purchases. How much room for manoeuvre do you still see here – or do you think that further interest rate cuts would be counterproductive? I’m referring to the reversal rate here.
As you know, the ECB Governing Council is explicitly not ruling out interest rate cuts, meaning that the reversal rate has not yet been reached, in our opinion. So further interest rate cuts are possible. But at the end of the day, it’s always a matter of weighing up the various instruments, their effects and their side effects.
Some central banks have broadened their toolkit to include share purchases, for example. Is this absolutely out of the question for you?
The further a central bank strays from its traditional toolkit, the more distorted market interventions become. For example, buying shares would mean that a central bank confines itself to a very specific group of enterprises and might even slip into an ownership role to some degree. That's hardly compatible with the tasks of the Eurosystem and its independence, if you ask me.
It would certainly be taking market intervention to an extreme if the ECB simply took complete control of the yield curve, like the Bank of Japan. Would you then counsel against this, too?
I don’t intend to give you a rundown of all the theoretically conceivable instruments we could implement. As I just said, it’s always a matter of weighing up an instrument’s merits. What’s always crucial is that an instrument is actually permissible. The European Treaties require us to respect the market economy. If the ECB were to start setting individual prices in the economy, there might come a point where it’s hard to reconcile this with a market economy system.
Overall, there seems to be a deep-seated impression among market participants that central banks will always step into the breach when things go wrong. Do you think the ECB will ever be able to break out of this role?
In my view, market participants shouldn’t conclude from the bold intervention in the spring that central banks will always come to the rescue. Central banks stepped in then because the economic turmoil posed a threat to price stability. Looking ahead, though, I can certainly imagine that the huge rise in government debt will make the risk of fiscal dominance much more acute, which is problematic. Pressure could mount on central banks going forward to keep interest rates and thus government funding costs low, even if this is no longer appropriate from a monetary policy perspective. That’s why we need to be very clear that we are not putting monetary policy into the service of fiscal policy.
Many English-speaking economists, in particular, have stopped considering the separation of fiscal and monetary policy to be such an important matter, and even no longer regard monetary financing as any great evil – and government debt per se is not thought to be all that bad anymore in times of low interest rates. By continuing to worry about such things, are the Germans stuck in the past?
It would be a mistake to project the current situation into the future. At present, fiscal policy and monetary policy are aligned such that they are looking to work in the same direction. But that doesn’t mean we should pretend that the two policy areas only ever pull together as a team. Should conflicts arise in the future, independence will be essential if the central bank is to show some backbone and pursue its objective of price stability.
That brings us to the heart of the debate surrounding the ECB’s strategy review. You are saying the ECB should focus narrowly on its price stability mandate. Others, meanwhile, like your fellow ECB Governing Council member François Villeroy de Galhau, are explicitly referring to a “two-stage mandate” and emphasising secondary objectives such as support for EU economic policy – issues such as employment and growth, in other words.
Ultimately, price stability is the best contribution monetary policy can make towards the achievement of these other goals. That applies to the objective of financial stability, but it also holds true for employment. Things get complicated when there is a conflict of aims. In that situation, it needs to be clear that monetary policy is committed to the objective of price stability. We have only been granted independence to work towards this objective. We have no mandate to pursue other aims in our own right or to play an active role in other policy areas. Those decisions are the responsibility of governments and parliaments. The same applies to climate policy. That being said, I strongly believe that the Eurosystem must take greater account of climate change when carrying out its work.
What does that mean specifically? Let’s take the idea of “green” targeted longer-term refinancing operations (TLTROs). Is that something that could still work? As we know, you take a critical view of explicitly favouring green bonds when it comes to the purchase programmes.
As I see it, the first and most important step is to better capture the financial risks associated with climate change. This is an area where we, the Eurosystem, can play a key role. For example, by tying the purchase of securities or their acceptance as collateral to transparency requirements. Not only would this improve our own risk management, but it would also raise the bar in terms of market standards. We also need to take greater account of the financial risk associated with climate change in banking supervision and when monitoring financial stability. And we need to adapt our economic models to improve coverage of the impact of climate change and climate policy. Expecting central banks to themselves remedy market distortions with their toolkit would be problematic, however.
What exactly do you mean by that?
Assessing and correcting market distortions is clearly the remit of politicians, who have the instruments to do that. They can influence CO2 prices through taxation or emission allowances, for instance. Bans and targets are also an option, and international treaties can be made. Combating climate change is, I think, a once-in-a-century task and one that needs to be pushed forward now. But it is not up to monetary policy to set the tone here, just as it isn’t when it comes to industrial policy or distribution policy. A narrow mandate and independence are two sides of the same coin.
The focal point of the strategy review is the issue of inflation, though. The Federal Reserve System is now applying a policy of average inflation targeting. What that boils down to in practice is years with inflation rates above 2% after years below the 2% mark. Does the ECB have any choice but to follow suit – without running the risk of the euro appreciating even more strongly, for example?
If the ECB had absolutely no other option apart from to copy the Federal Reserve’s strategy, there would be no point in us having this discussion in the first place. There are many aspects of the Fed’s new strategy where it has yet to go into specifics. And, with its dual mandate, its objectives are also different to that of the Eurosystem. Besides, the exchange rate has been moving more or less sideways since the announcement. A decision as fundamental as monetary policy strategy should not be made on the basis of the exchange rate but rather on how we can best maintain price stability in the euro area.
But, many of your colleagues in the Governing Council, including ECB head Christine Lagarde, seem quite keen on average inflation targeting.
The idea behind average inflation targeting is for temporarily higher inflation expectations to exert a stabilising effect at the lower bound, making up for the paucity of standard instruments. However, the concept places very high demands on households, enterprises and market players. You see, they have to understand it and form their expectations accordingly. And there’s a practical problem, too, that arises when inflation has been moving above the target for a few years: the central bank would have to force the inflation rate below target, taking it into a region which the central bank currently views as dangerous. What central bank is going to risk a recession by hiking interest rates significantly just to offset the overly high inflation of the past? So, an average inflation targeting strategy could be designed as an asymmetric mechanism, but then you may well end up with a higher average inflation rate than originally planned.
So where do you believe changes need to be made to the ECB’s strategy?
First off, we need to examine whether we are measuring inflation correctly. There are good reasons, for example, to add owner-occupied housing to the Harmonised Index of Consumer Prices. Second, we have to consider whether measurement errors have increased or decreased. Needless to say, other major topics include how we define price stability and formulate our policy aim – that is to say, what inflation rates we are looking to achieve for the euro area. On this front, I am pushing for us to formulate our policy aim in comprehensible and realistic language. We should not give the impression that we are able to steer inflation precisely within a given quarter.
Would the ECB’s target be more readily comprehensible if it were a straight 2%, perhaps with a tolerance range on either side of that?
In principle, a straight, symmetrical inflation target of 2% is certainly clearer and simpler than “below, but close to, 2%” combined with a definition of price stability that includes inflation rates only below 2%. At the same time, surveys on inflation expectations among households and analysts suggest that they have so far understood what we want to achieve. Also, the Governing Council deliberately expressed both the target and the time horizon with vague wording. Monetary policy works with a time-varying lag, and it is important to incorporate this into the target’s wording, including giving it a medium-term orientation.
Another topic of intense debate is the launch of a digital euro. The ECB now intends to launch a trial period. Is central bank digital currency necessary?
First and foremost, there needs to be a precise definition of what is meant by “digital euro”. Some are talking about payment systems and their performance, whilst others are speaking of programmable money, and yet others of central bank digital currency. The chief concern for consumers is to be able to pay quickly, securely, conveniently and cheaply – including across borders. This can be achieved by upgrading the payment systems that are already in place. It may also be necessary to introduce mandatory instant payments. Business customers, meanwhile, are keen to use programmable money for smart contracts. This can be provided by banks without any need for central bank digital currency. What makes central bank digital currency unique is that, even if cash use declines, it is still possible to hold a claim against the central bank.
And you're rather sceptical about central bank digital currency?
I certainly see opportunities to make payments more efficient, including with the use of central bank digital currency. That said, we should not underestimate the problems that it could entail, especially for the banking system and financial stability. While such risks could be ringfenced by imposing upper limits on holdings of central bank digital currency, say, there is the danger that political pressure might end up being so strong as to soften any meaningful restrictions. So we shouldn't be hasty here. Designing the payment systems of the future requires prudence and foresight just as much as innovation and openness.
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