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Interview with Pierre Wunsch, Governor of the National Bank of Belgium and Member of the ECB’s Governing Council

"We are not inflation fetishists"

Mr. Wunsch, the coronavirus is spreading worldwide and is frightening the financial markets. How worried are you about the economic impact on the euro area?Pierre Wunsch, Governor of the National Bank of Belgium and Member of the ECB’s Governing Council

The big problem is that we do not have a good comparison. Of course there was SARS, but the outbreak then was much more limited than it is today. Nor is there much experience with such supply shocks in times of highly globalized value chains. Not long ago, the basic assumption was that there would be a V-shaped recovery. The virus would dampen growth in the first quarter, especially in China, but also globally, but thereafter the situation should increasingly ease once the spread has been halted. I guess it is now obvious that this is not the only possible scenario.

What does that mean? Do you see a risk that the virus could plunge the weakening euro economy back into recession?

The coronavirus can dampen economic growth to such an extent that it is lower than assumed in our projections. This would be a cause for concern, as inflation is already below our target of below but close to 2%. We have to be very vigilant about this.

But so far the ECB's baseline scenario is still that of continued moderate growth and some economic recovery in the course of 2020?

There are a number of risks for the euro area economy. For example, the danger of a disorderly Brexit is still not completely eliminated. In addition, trade conflicts may flare up again. If US President Donald Trump were to be re-elected, there is a danger that he will take action on the trade front against Europe. US tariffs on EU car imports would hit the euro area economy hard. The coronavirus is now a new threat that extends this list of risks. So, it is fair to say that the risks for the euro economy are tilted to the downside at the moment and that the uncertainty has increased significantly.

But the previous baseline scenario is still valid or not?

The economic signals have recently been mixed, which makes it somewhat difficult to assess. The latest purchasing managers' indices for the euro area have turned out surprisingly positive. Recent months have shown that the euro area economy has been able to withstand some negative shocks. The fact that the PMIs have recovered despite the coronavirus and other problems suggests that there was an underlying positive momentum in the euro area economy. That gives hope. This is also true for the industrial sector, which has now been on a steep decline for two years. So far the euro area economy is on track and is developing broadly as we have expected.

So the hoped-for recovery is not yet over?

No, certainly not. A V-shaped recovery could even mean that the recovery after the setback will be all the stronger. You shouldn't count on that, but it is a possibility. The economic recovery in the euro area may be delayed by a quarter or two, but it is not derailed.

Is inflation also moving further in the right direction?

The underlying price pressure has increased in recent months, and had risen to 1.3% at the end of 2019. This is exactly the trend we were hoping for. In January, the underlying price pressure decreased again somewhat, but this was mainly for technical reasons. Inflation is moving in the right direction and basically as we have assumed.

Does the current situation finally justify the far-reaching easing of monetary policy in September - including the relaunch of broad net asset purchases (Quantitative Easing, QE)? The resistance in the Council was unprecedented, especially against QE.

I was in favor of the comprehensive easing package in September because it was already fully justified in the situation at that time. The weakening of the euro area economy had turned out to be more than temporary. Many countries grew below potential. Germany was even on the verge of a technical recession. There was a great risk that the low growth would solidify or that the economy would even crash. If the economy had slipped into recession, it would have been even more difficult to achieve the inflation target in the foreseeable future. I would not say that we alone prevented a recession, but we certainly contributed to it. What I strongly believe, however, is that if we had known in December 2018 what we knew in September 2019, we would not have stopped QE net asset purchases at the end of 2018.

So this step was a mistake?

The end of QE at the end of 2018 was justified by the expectation that the euro area economy would recover quickly and pick up again in 2019. Unfortunately, that did not happen. So the restart of QE in September was actually a no-brainer for me.

But obviously not everyone in the Governing Council saw it that way.

There was a clear consensus that we had to do something. However, there were discussions on individual instruments and, in particular, on the question of how effective each instrument still is - and that is legitimate. Incidentally, for most people, strengthening forward guidance was the most important measure. Ultimately, however, a majority voted to act on all fronts. Another decisive factor was the fact that a package of measures is more effective than the sum of the individual measures. We estimate that the measures have a significant positive effect on growth and inflation.

Should asset purchases in particular not be reserved for emergencies and not serve to fine-tune inflation?

We will certainly have this discussion again and more intensively in the course of our strategy review: Which instrument is used in which situation? Many people are of the opinion that in times of a significantly lower real equilibrium interest rate, the unconventional instruments will become part of our normal toolbox. In such an environment, interest rate alone can no longer do the job. For the US, there are analyses by former Federal Reserve Chairman Ben Bernanke, according to which the unconventional measures have corresponded to around 300 basis points of interest rate cuts. We must also analyze this for the euro area. But I would like to make one more point.

Please do.

September was also about showing that we are really determined to act. The lesson from Japan is that it can be dangerous to do too little and too late. Piecemeal monetary policy only increases the risk of having to remain expansionary for much longer. A central bank must leave no doubt that it is determined to act and capable of making a difference. Otherwise, it will only multiply the uncertainty in the system.

However, ECB President Christine Lagarde recently stated that the ECB's room for manoeuvre is now considerably reduced. Nevertheless, market participants are already speculating on further interest rate cuts, also in view of the coronavirus. Does that worry you?

If there is a risk of a recession, we must do everything possible. But you also don't have to act on every negative shock once your forward guidance is properly interpreted by the markets. The yield on ten-year German government bonds is currently around -0.6% and euro inflation is around 1.3%. The real interest rate is thus just under -2%. This is well below even the most negative estimates for the real equilibrium interest rate. The current stance of monetary policy thus supports the economy on its path towards potential growth and higher inflation.

And in case of doubt, everything else must be directed by fiscal policy?

Low and negative interest rates allow for a fiscal response in an emergency. Some plead for a more sustained stimulus, and some countries are already acting accordingly. And there are countries like Germany that have more fiscal room and for whom it could make sense to do something. My plea, however, is that we should not rush to fire our remaining fiscal ammunition. The euro economy is not in recession and jobs are still being created.

So it is still too early?

I am very concerned when I hear about Modern Monetary Theory or about “green deals” financed by the central banks. People are mixing up cheap money with free money. But we should not forget this distinction! The last sovereign debt crisis in Europe was not even ten years ago and there are already people who say that with zero and negative interest rates there are no limits to sovereign debt. I can only warn against testing the markets again. The point is to have enough fiscal leeway to face the next recession, whenever it comes. 

The ECB is now also reviewing its strategy - for the first time since 2003. This especially focusses on the medium-term inflation target of below but close to 2%. Do we need more clarity or more flexibility?

I do not want to anticipate the discussions. There can hardly be any doubt that the definition of our aim is not as clear as those in other regions. And then there is also the question of the symmetry of the objective. But for me, two other issues are ultimately more important: firstly, the fall in the real equilibrium interest rate and the question of whether our toolbox is sufficient to deal with it. And the second is the question of the Philips curve, i.e. the relationship between capacity utilization and inflation. Behind this is also the question of whether the relationship has changed structurally and whether a more expansionary monetary policy will be needed in future to have the same effect on inflation. We still know far too little about this.

But you see a need for more clarity in the definition of the objective? Some of your colleagues plead for a symmetrical target of exactly 2% - possibly supplemented by a tolerance band.

There are certainly good reasons for more clarity regarding our definition of price stability and our aim.

There are also discussions with the public planned under the motto "The Eurosystem listens". At the events organized by the US Federal Reserve, a central finding was that people are relatively indifferent to inflation below target. Doesn't this lead the monetary policy of the past years ad absurdum?

The listening events that we plan in the Eurosystem are important and I fully support the ECB’s initiative. I am looking forward to the feedback that the various stakeholders such as the public at large, academics, economists, politicians, financial sector and others will give us. But indeed we don't need to wait for our "listens" events to know that people in the euro area don't care too much about a low inflation rate. Most people do not even know what inflation and monetary policy are. We clearly face a communication and education challenge there.

That means?

Of course, one can argue about the mandate and the objective. But I try to take a different perspective when I interact with people that are less familiar with monetary policy : I make it clear to those people that the ultimate goal is to stabilize inflation in order to stabilize the economy. The issue is to create more monetary policy leeway again through higher inflation to be able to push real rates lower, if that should become necessary. We are not inflation fetishists who just stare at an inflation aim. In the end it's always about the real economy. Hopefully we can find ways to communicate that to a broader public.

It will also be examined whether the ECB should play a more active role in the fight against climate change. What is your assessment of this?

We are an independent central bank and this independence is even guaranteed in the EU Treaty. But that goes hand in hand with a narrow mandate - price stability. We cannot play the stopgap role for politicians if they cannot agree on some issues. Again, this is about the distinction between cheap money and free money. If the impression is being created that there is unlimited money for green objectives, because these are important, and the next day for health care, because it is also important, and then for education and so on - then we would be in big trouble.

What does that mean in concrete terms? What can the ECB do - and what cannot??

Climate change creates new risks and we need to understand them better. The main issue is how the transition will change the economy over the next two to three decades. If the EU wants to make Europe CO2-neutral by 2050, that means: no more coal, no more oil, and probably no more natural gas either. It is a tremendous upheaval. For us, a particular concern is of course the implications of climate change for financial stability. As a central bank, we should also look at our collateral management and see whether or how climate risks should be taken into account. But I would be reluctant to do anything that amounts to using monetary policy directly in the fight against climate change.

Is the EU Commission overshooting the mark with its target of CO2 neutrality by 2050?

As far as the basic direction is concerned, I agree 100%: we must do something. And I am optimistic that we can do a lot without harming our economy. But if we want to be CO2-neutral by 2050 or any other date, this will only work with new technologies that do not exist today. That does not mean that they will not be there by 2050. But we do not know. If this objective was set in stone and there were absolutely no flexibility left, I would be worried. Particularly if you want to be a climate pioneer and other countries do a great deal less, you have to be very careful not to kill off your own economy. The planned CO2 border tax makes a lot of sense in this respect. But in today’s world, it will be very difficult to implement this politically.

The EU Commission also wants to create leeway in the EU fiscal rules to combat climate change. Is that right?

Again, one should not go and pretend that some risks are not risks just because they have a green coat of paint. The sustainability of public finances is an important objective - quite apart from climate change. Nor can it be said that EU fiscal rules have not been flexible in recent years. If the idea would be to make the rules more binding again overall and in return create some leeway for green investment and public investment in general, that could be acceptable. But I would refrain to extend the existing flexibility even further.

There is also an intense debate going on about reforming monetary union. Keywords include the euro budget, common deposit insurance (Edis) and a European "safe asset". However, progress is limited. Does that frustrate you?

If I may, I would like to answer this question in a broader context, because it is a matter of great concern to me: when the euro was introduced, it was done under very specific circumstances and conditions. There was no referendum. People were told that not much would change. There was the no-bailout clause, the Germans were on board, and the ECB was modelled very much on the Bundesbank. If I may put it a bit bluntly, we did not go to the people and say that it was about creating the United States of Europe.


But now I have the impression that many people abstract from these historical circumstances and sort of imply that choosing the euro was actually a choice for a much deeper integration – that we would not have the choice anymore. This makes me uncomfortable. They claim that the euro is fundamentally weak and that if this, this or that does not happen, the euro will not survive - be it safe assets, a euro budget or Edis. Many have entered into this narrative, sometimes to create momentum. But it is fair to say that not much has happened for lack of political consensus. Now, one should always be ready to improve on the existing framework and some changes would certainly be useful. But there is currently a lack of trust that prevents moving forward.

And what now?

Some debates have taken a very symbolic dimension. Take Edis as an example: those who are in favor of Edis are regarded as good Europeans; those who are against it are regarded as bad Europeans. That is not helpful. What's more, the super-seniority of protected deposits has actually essentially done away with the Edis issue. We have made simulations according to which Edis would not even be used if there were another financial crisis like the one in 2008. To me, the most pressing issue is the introduction of concentration limits for government bonds in bank balance sheets. Without them, the doom-loop between banks and sovereigns cannot be avoided.

But does that mean that without such progress we will have to prepare ourselves for the euro area to remain in a permanent crisis mode?

Some criticize, for example, the lack of well-defined solutions in case one big country goes bankrupt, Italy being often cited to make the point. But of course there are none! The fiscal rules are there to ensure that this does not happen to begin with. So, how could we clearly decide on a solution beforehand? I believe this criticism is fundamentally unfair. But as far as your question is concerned, we have survived a one-off financial crisis and we have survived a one-off euro crisis - without many of the instruments and institutions we have today, such as QE or the ESM. Now we have these instruments in place. I also believe that it is part of the ECB's mandate to safeguard the euro, and that can mean buying time for political solutions to emerge. With the instruments we now have, we should be able to find a solution in the event of a crisis. To put it a bit strongly again, to keep saying that we need the United States of Europe for the euro to survive is to shoot ourselves in the foot. Because we will certainly not have the United States of Europe in the near future. So we must change the narrative!

And how?

There are many ways in which Europe can prove its value. Climate, migration, geopolitical conflicts - these are just some of the pressing issues. We need a positive story telling about Europe again.

Pierre Wunsch is Governor of the National Bank of Belgium and Member of the ECB’s Governing Council.

The interview was conducted by Mark Schrörs.
Börsen-Zeitung, 2.3.2020