Weidmann: PEPP will end once the pandemic is over Interview with Jens Weidmann in the Berliner Zeitung.
Interview with Jens Weidmann conducted by Katharina Brienne and Michael Maier.
Translation: Deutsche Bundesbank
In 1987, the writer Hans Magnus Enzensberger published a collection of essays entitled
“Europe, Europe – Forays into a Continent” – a pamphlet about the centralised administration of Europe in Brussels. In it, he wrote that
“forced unity and homogenisation” were bad for us and that
“it’s our diversity that saves us.” On the other hand, Jacques Delors, president of the European Commission at the time, quipped that one could not fall in love with the single market. Mr Weidmann, how do you feel about the European Union today?
My CV is very European. After graduating from school with my Abitur, I set off to begin my university studies in France because I was curious to learn more about our geographical neighbour. I wanted a new perspective. And that is a key part of what it should be all about: being open to getting to know the peculiarities, the special characteristics, the advantages of other societies in Europe and finding out that we are stronger together than by ourselves.
Allow us to look back on the October 1990 issue of the Bundesbank’s Monthly Report and how it discussed the monetary union which was then established in Maastricht in 1992. It says in the report that such a union would be
“an irrevocable joint and several community” requiring “a more far-reaching association, in the form of a comprehensive political union, if it is to prove durable.” There were even some outside the Bundesbank who voiced the concern that monetary integration without real economic convergence and a common economic and fiscal policy could not succeed long-term. 30 years on, how do you view this debate today?
A core idea is, in fact, that the European Union will only be accepted by its citizens if it keeps its promises. This includes the European Union – and especially European monetary union – being a union of stability. Something that is predicated on certain conditions. That is what this debate was about, and that is still the issue today. Ultimately, the starting position is that the Member States agreed to create a single monetary policy but were not willing to surrender fiscal sovereignty. The countries insisted on retaining broad independent responsibility for economic and fiscal policy matters.
What have been the consequences of this, from your perspective?
This kind of design of monetary union is very challenging and can create tension. Going forward, this may also turn out to be a problem for the stability orientation of monetary union – if, for instance, high government debt leads to pressure being put on monetary policy makers to relieve the debt burden through low interest rates. One way of forestalling this is by imposing discipline on national budgets: for one thing, through clear and binding rules, especially governing budgetary management; and for another, via the financial markets, through unsound fiscal practices entailing higher funding costs. Unfortunately, looking back, this has not always worked well on the whole.
Berliner Zeitung: And what is the alternative?
The other way of maintaining the balance between actions and liability is through a single fiscal policy. It is not per se a guarantee of a stability union, because even a single fiscal policy can be unsound. But fiscal decisions would then be taken jointly, and liability would likewise be shared. Among the possible dangers is that one country could run up debt at the expense of the others, thus creating a greater incentive to borrow than if each country were responsible for its own fiscal affairs. When the monetary union was established, however, the countries involved were not willing to go that far. In my opinion, they still aren’t. The fiscal rules – such as they exist today and as we are implementing them – are a very soft-touch form of coordinating national fiscal policies. But even that is often accepted only grudgingly. In addition, decisions taken in a centralised manner require democratic legitimacy, too.
From the very beginning, observers and stakeholders were worried that the monetary union could become a debt union. Given the developments concerning measures such as the European Stability Mechanism (ESM), haven’t we already reached that point now?
The ESM was created in the aftermath of the sovereign debt crisis, and Germany’s participation was also ratified in the Bundestag (lower house of the German Parliament). In the current crisis, too, the states have chosen to demonstrate solidarity and give each other fiscal support. Joint debt such as is envisaged in the Next Generation EU (NGEU) reconstruction fund should be temporary and closely tied to the crisis, as otherwise the governance framework of the EU could potentially be extended further and further, without a conscious and transparent decision having been made to take this path. A fiscal union must not be allowed to be introduced through the back door. I believe it is necessary to have an open debate in society on the shape of Europe going forward – and also on the preconditions for stability and soundness. That will promote acceptance and therefore rally the public around this idea. And once a path has been chosen, it needs to be firmly enshrined in law. The Federal Constitutional Court (Bundesverfassungsgericht) was correct to keep constantly returning this debate to where it belongs – in parliament and ultimately in society.
Another related aspect that came under repeated criticism during the debt crisis in particular was that, through their crisis programmes, the European institutions primarily propped up banks which, following the financial crisis, were in danger of collapsing a second time in the debt crisis. During the coronavirus crisis, a debate has resurfaced with regard to enterprises receiving publicly funded support – such as Lufthansa in Germany.
You have brought up the “too-big-to-fail” problem: that certain banks could be too important for the financial system to allow them to fail should they become distressed. If, however, it is expected that the state will come to the rescue in an emergency, this can lead banks to become negligent or reckless. I believe that the public is right to expect decision-makers in the political and supervisory arenas to address this problem. And substantial progress has been made in this regard since the financial crisis, too. On that note, there’s one thing we mustn’t forget: stabilising the banking system also protected savers’ deposits. It averted substantial macroeconomic turmoil and thus ultimately benefited the entire general public. Generally speaking: in a crisis, policymakers need to make decisions under great uncertainty. In such a situation, the state has to act to prevent matters from getting worse – even if it turns out after the fact that this or that could possibly have been done better. That is why the state responded rapidly and comprehensively in the current crisis, too. And aid was given not just to large enterprises but also to smaller firms, the self-employed and households. One can quibble about implementation: was it quick enough? Too much red tape? Did it reach the right people? However, it is important to provide help in order to cushion the effects of the crisis.
As regards the debt crisis and the support measures, the subsequently very accommodative monetary policy of the European Central Bank has been the topic of constant debate since then. If we look at the movements on the stock markets, which can also be described as an outcome of this monetary policy, that seems to be a difficult sell to the public. While some are on short-time work, stock prices have gone back through the roof, aside from a brief interruption caused by the pandemic-induced crash in March 2020. Many indices, such as the German leading index, have been at all-time highs as of late. Apparently, there is confidence among stock market participants that the ECB will not raise its policy rate for the time being. Can that go on ad infinitum?
By supporting the economy by creating, amongst other things, favourable funding conditions, monetary policy helped to prevent many people from losing their jobs during the crisis. It is therefore having a broad impact – on banks, enterprises and households – and must not be reduced solely to its effects on asset markets. But you are right, of course. Interest rates are a fundamental factor in corporate bond valuations, for such shares create claims on an enterprise’s future profitability. The higher the interest rate, the more valuable the expected income flow will be today. Enterprises’ interest burden declines as well, and if the economic outlook is better, profit expectations improve. However, our standard models are currently suggesting a rather high valuation on the stock markets.
When and how do you expect this overvaluation to go back down again?
Such model-driven results should be treated with great caution. Prices are quite capable of diverging from fundamentally justified values for prolonged periods of time. And models, naturally, are not a perfect representation of the real world and are themselves fraught with uncertainty. I do not wish to predict stock prices at this juncture. To illustrate this: assets such as equities or real estate are linked to the future outlook – in other words, they are steered by quite subjective assessments. What we are seeing on the stock markets, in particular, is that the assessment of the pandemic there is preceding current developments. And if you, as an investor, assume that interest rates will remain low, you will sooner be willing to pay a higher price for an asset such as a stock than if you assume that monetary policy is on the cusp of normalisation.
Suppose the development we are seeing here doesn’t just reflect a passing trend, but is a permanent fixture – namely, stock markets that are decoupled from the rest of the system and that have even been known to plunge governments into crisis, as we saw in Greece during the debt crisis. As well as a common fiscal policy in the EU, don’t we also need more control over the stock markets?
It’s safe to say that the stock markets weren’t the root cause of the debt crisis. Broadly speaking, price formation in the stock markets plays an important economic role. Ultimately, it means that capital generally flows to where it can be used the most productively. Investors can generate earnings from the stock market, but not without taking on the corresponding risk. So if they make mistakes, they also make losses. From a macroeconomic perspective, that isn’t a problem as long as it doesn’t impair the functioning of the financial system. It would be different if banks were to fail, because that, in turn, could mean they were then unable to lend and the financial system would no longer perform its function for the economy.
But market expectations haven’t always been right in the past …
That’s a good point, but we mustn’t forget that there are often situations in which opinions regarding the future or the value of certain technology differ.
Consider the question of the extent to which IT can influence productivity and economic growth. Here we can see the “paradox of productivity” at play, which means that the productivity gains that innovations in IT were expected to produce are not yet reflected in the figures. Some people put this down to the fact that new technology is far less revolutionary than earlier waves of innovation, such as the industrial breakthrough caused by the invention of the steam engine. Others think it might simply take some time before economic structures have adapted, and that a boost in productivity is still around the corner. Think back to the dotcom bubble. Many people believed that the new economy was an absolute game changer that would transform the world in one fell swoop. We ultimately saw how those expectations failed to live up to the hype, and a correction took place in the stock markets. On the stock exchange, too, it’s all about discovering the next big thing.
Another visible effect of the ECB’s crisis-based monetary policy is that far more purchases than usual are being financed using loans because interest rates are so low and credit is therefore very cheap. What’s your opinion on that?
In today’s exceptional circumstances, we are seeing strong growth in the monetary aggregate. On the one hand, this is the result of individuals and enterprises taking out precautionary loans and holding more liquidity in response to the crisis. On the other, our monetary policy measures are a key factor. Against this backdrop, people are currently asking whether strong monetary growth will contribute to a sustained, significant rise in inflation. I don’t see any signs of that at present. In the past, although the monetary aggregate and inflation showed a close relationship when moderate and high inflation rates prevailed, inflation is currently low, and this relationship is not proving very meaningful. Besides this, we are basically in a position to take countermeasures through tighter monetary policy, which ultimately means higher interest rates. So from my point of view, it’s a question of willingness. Are central banks also prepared to reverse their measures in good time if needed to ensure price stability? Or will worries about potential side effects – for example, for financial stability or governments’ financing costs – dominate, so that the reins are tightened too late?
One term that crops up a lot in the debate is “zombie firms” …
What we are talking about here are unprofitable firms that should actually be insolvent and that are only being kept alive because loans are repeatedly being extended at low interest rates. There are concerns that the low interest rate environment is fostering developments like this. In some euro area countries, the share of these firms did indeed rise during the financial crisis and the subsequent sovereign debt crisis. But it’s not clear whether or to what extent low interest rates are responsible for this.
What do you make of the situation in Germany?
The share of these problem firms in Germany has actually fallen in the low interest rate environment. Of course, the pandemic is producing a whole new mix of factors. On the one hand, many enterprises are coming under serious pressure. Business models are also being called into question. On the other hand, government support measures are helping. At the end of the day, we expect the number of insolvencies to increase again from a very low level once these measures expire. As a result, credit defaults at banks are likely to rise – but, from today’s perspective, this will be on a scale that Germany’s banking sector can cope with. This is aided by the institutions’ relatively comfortable capital base, which is also due to the banking regulation reforms in the wake of the financial crisis.
Alongside your role as President of the Bundesbank, you are Chairman of the Board of Directors of the Bank for International Settlements, which is, in turn, associated with the Basel Committee on Banking Supervision – responsible, amongst other things, for the stricter capital rules imposed on banks after the experiences of the financial crisis. At the IMF’s Spring Meeting, your colleague at the Bundesbank, Vice-President Claudia Buch, recently warned against the reversal of this financial regulation during the pandemic. On the other hand, the European banking supervisory authority, which is based at the ECB, has pointed out that some models for calculating probability of default calibrated according to the IFRS 9 accounting standard are so “desensitised” that they can be used to “artificially” reduce credit risk. What is your take on this?
Those are two different questions. The regulatory and supervisory authorities have responded to the coronavirus crisis with a certain easing of their requirements. In particular, they have allowed banks to use capital and liquidity buffers where necessary in order to prevent institutions from excessively curtailing their lending, thus stopping the financial sector from fanning the flames of the crisis. But these are temporary measures. The point Ms Buch was making was that the Basel framework as a whole should not be called into question. Of course, after the crisis, supervisors will continue to apply the tried and tested standards that we have negotiated.
It’s no secret that you take a critical view of the ECB’s asset purchases. As early as 2012, you warned that they might have side effects. What do you think about the ECB’s current approach?
Large-scale purchases of government bonds can be an effective and legitimate monetary policy instrument. But they also entail serious risk – especially in a currency union consisting of independent member states. That’s why I have always said that government bond purchases should be an emergency tool. The pandemic is just such a classic emergency, in which I consider bond purchases to be justified. But here, too, it is vital to achieve the right scale, and the central bank must not engage in the monetary financing of governments. Even before the pandemic, we were the euro area Member States’ largest creditor. Together with the sovereign bonds already accumulated, holdings of public bonds by the Eurosystem – by which I mean the ECB and the other national central banks – could start to approach 40% of euro area GDP next year. When the Eurosystem launched the first purchase programme about ten years ago, some people hoped that the use of this instrument would only be temporary. This has not been the case. My concern at the time, which was that fiscal policy would increasingly engulf monetary policy, still worries me today. This mixing of monetary and fiscal policy may also mean that it becomes more difficult for monetary policymakers to ensure price stability.
What are the knock-on effects of fiscal policy “engulfing” monetary policy?
If the central bank purchases large volumes of government bonds, Member States are partly shielded from the capital markets. This can weaken the market discipline of fiscal policy which, as I mentioned earlier, is actually a key element, alongside the fiscal rules. Moreover, through the purchases, the financing costs for this part of sovereign debt are ultimately linked – via the balance sheet connection between the central bank and public finances – to short-term central bank interest rates. To this extent, the interest rate the central bank pays on banks’ large deposits is currently of relevance. This means that for the government bonds on central banks’ balance sheets, each finance minister pays the same rate of interest, regardless of their respective country’s creditworthiness.
However, as a result, future changes to key interest rates will also have a greater impact on public finances. Particularly in light of the sharp rise in debt stemming from efforts to combat the pandemic, this could, in turn, actually put pressure on monetary policymakers to keep interest rates lower for longer.
The public debate seems to envisage only two ways out: one appears to be via a debt union managed through a joint fiscal policy. The other is for governments to go bankrupt.
No, such doom and gloom is excessive. A debt union and sovereign insolvencies are extreme scenarios, and the precise purpose of sound policymaking is to avoid them.
Yet we central bankers should state very clearly that we will tighten the monetary policy reins again if the price outlook requires it, and will do so regardless of whether this increases borrowing costs for governments. Otherwise, false expectations could potentially be raised and additional debt run up, which would further increase the pressure on central banks. However, central banks should not even be put in a predicament where their only choices are, on the one hand, to subordinate their objective of price stability or, on the other hand, to accept risks to financial stability or sovereign debt crises that could arise given higher borrowing costs for governments. That is precisely why we have fiscal rules. That is precisely why we need market discipline. And that is precisely why monetary policy should not become too tightly interwoven with fiscal policy.
In 2020, the Bundesbank increased its risk provisions by €2.4 billion to €18.8 billion and hence did not distribute any profits, for the first time since 1979 – unprecedented since your institution was established 64 years ago. Banca d’Italia, on the other hand, distributed profits of €6.3 billion. The Italian central bank’s total assets now come to €1,296 billion. Last year alone, it purchased €116 billion worth of bonds, meaning it now has bonds in the volume of €473 billion on its books. What is your view of that?
The effect of bond purchases on the profit and risk situation varies widely from one central bank to the next. This is partly because we consciously decided not to introduce a liability union for sovereign default risk via the central bank balance sheet. Banca d’Italia only holds Italian government bonds, which carry a relatively high interest rate owing to the risk premia on Italian debt, whereas our books contain Bunds with a lower interest rate. Because of the low interest margin, the Bundesbank earns particularly low interest income compared with some of its counterparts – on very safe bonds. This means that interest rate changes can also more quickly lead to losses for us. In this context, the Bundesbank assesses risk on the basis of recognised risk measures and using model-based analyses. This model-based assessment flagged an increase in risk and we therefore stepped up our risk provisioning.
What time horizon do you use in calculations concerning the two issues of interest rate reversal and the asset purchase programme?
For monetary policy to be normalised, we need to see progress towards our objective of an inflation rate of below, but close to, 2% in the euro area over the medium term. In their latest forecast, ECB staff project an inflation rate of 1.4% for 2023, the end of the forecast horizon. However, forecast uncertainty is especially high at the moment, and inflation could certainly pick up more strongly for a time in the next few quarters. Our objective is a medium-term one, though, and monetary policy looks through short-term fluctuations in the euro area inflation rate. That is why financial markets are not expecting a significant tightening of monetary policy in the foreseeable future, either. In any case, the first step would be to cut back on asset purchases, before key interest rates are raised. This has also been clearly communicated by the Governing Council of the ECB.
What do you expect for the next ten months, for example?
Naturally, I never predict the decisions the ECB Governing Council is going to make. But this much I can say: the emergency purchase programme, PEPP, is clearly tied to the pandemic and will end once we overcome it. When exactly that will be, though, no one can currently say for sure. In that respect, we’re taking things day by day.
Economic activities are more and more enmeshed with each other and thus also more susceptible to external shocks. We noticed this at the start of the pandemic mainly with supply chains. As a central banker, what is your assessment of risks stemming from geopolitical tensions?
Growing rivalries between economic areas as well as the pandemic could both very well foster deglobalisation tendencies. During the first lockdown, international supply chains were broken in some cases; a number of production lines came to a standstill. That’s why there are calls to once again rely more heavily on production at home and thus to become less dependent on deliveries from abroad. However, this in turn would make the economy more vulnerable to domestic disruptions. You can’t make an economy more resilient by switching from one cluster risk to another. At the end of the day, diversified production structures help to overcome disruptions and crises like the ones we are experiencing now. A policy of isolation robs economies of the advantages of the international division of labour and, at the same time, makes them less robust than some would hope.
Quite aside from all these issues, one completely different and pressing subject has come to the fore of late: that of the e-euro. ECB President Christine Lagarde has been talking for quite some time now about a potential digital currency which could be issued by the ECB as legal tender, alongside cash. This can be understood as a response to developments surrounding the “DLT-based economy” – and the idea that value chains and business processes will, in future, be settled partly via the blockchain – and could thus become more decentralised. What is your perspective on this?
First of all, if a central bank issues a different form of money, that is not decentralisation. Even if we were to introduce a digital euro, the Eurosystem would remain the central player, or even gain more influence. When considering this issue, the Bundesbank’s priority is to ask: what do the public want? What do businesses need? How can payments be made conveniently, cheaply and securely, and, at the same time, online? In my view, these considerations are sometimes missing from the debate.
So how do you think payments could be improved?
In the world of online payments, speed and low transaction costs are the clinchers. But even now, it’s possible to make instant payments which are secure, immediate and final. There is also growing interest in programmable payments, allowing an electric car, say, to pay for its electricity automatically at the charging station.
This can probably also be achieved by continuing to develop existing systems. Consumers should have a choice of payment medium, though. And central bank digital currency could have the potential to facilitate innovation. We are therefore seriously looking into central bank digital currency, but should not lose sight of other solutions beyond that. In any event, the interface to customers should be the financial and banking system, as before. It’s important for central banks to provide the scaffolding for payments, but the private sector must come up with the range of services offered to consumers.
But couldn’t the digital euro still be a good supplement to the book money of commercial banks – simply because the ECB as an intermediary enjoys such a high level of trust?
People already trust that their money is safe in their bank accounts, though – and rightly so. Banking supervision and deposit protection also make sure of this. And they can already use this money for digital payments today, via card or smartphone, say. What we’re talking about is giving people the option of paying with central bank money in a digital setting as well. But we need to design the digital euro such that it provides added value and that the risks and side effects of this very fundamental step are kept in check. You see, it could have implications for the structure of the financial system and its stability, amongst other things. That’s why restrictions are being discussed, such as a cap on the amount of this currency that each person would be allowed to hold.
From time to time, observers have also been discussing the extent to which the digital euro could see the issuance of programmable money – which, if it were programmed with a purpose, could only be used for that purpose.
The idea of programming money so that it couldn’t be used to buy cigarettes anymore, for example, seems absurd to me. Central bank digital currency has to be a universal means of payment, like cash. What’s clear is that the crux of this whole debate is not the abolition of cash. Cash is still an attractive means of payment in many situations, and the Eurosystem will continue to provide it.
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