Interview with Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania and Member of the Governing Council of the European Central Bank (ECB)
Mr. Vasiliauskas, growth in the euro area economy almost halved from 0.7% to 0.4% at the beginning of the year, and the big question is whether that is a slip-up or a turning point. On a scale of 1 equal to "not worried at all" to 5 equal to "extremely worried" - how would you rate your concerns about this slowdown?
So you are not too worried.
We have always expected a slowdown. So that's no big surprise. It was also clear that at some point there would have to be some normalization in the pace of growth. In the long-term you cannot grow so much above the potential rate as we did in 2017. Finally, there were also special factors. The slowdown should only be temporary. We continue to expect solid and broad-based growth. We have to wait until June, what our new projections will tell us. But there is no reason to dramatize the situation today. That is certainly not the end of the recovery.
You talk about special factors. Has the significant appreciation of the euro in the past year also played a role because it dampens exports?
I don’t think that the euro appreciation was a key factor in the slowdown. Factors such as the weather or the Easter date played a more important role. But you should also not look too much at a single factor. It is the interaction. But again: One should not overestimate the slowdown.
Some observers also refer to the halving of the asset purchases by the European Central Bank (ECB) from 60 billion euros to 30 billion euros at the beginning of the year.
I think that's exaggerated. One should not forget: Monetary policy in the euro area is certainly still very expansionary even with the halving of the purchases.
How worried are you about the global trade disputes - could this put an end to the recovery in the euro area?
So far the direct impact of the trade disputes on the euro area economy and on the growth outlook is rather limited. However, a large potential risk is indirect consequences, such as corporate confidence and investment activity. As ECB we have to monitor this very closely.
There have been many risks in recent years, but the euro area economy has proved to be quite resilient.
You're right and that's encouraging. At the same time, it is clear that exports are very important for the euro area economy. If there are major upheavals or disruptions in global trade, this will not go unnoticed in the euro area. I sincerely hope that all partners will remember and stick to the benefits of free world trade.
Inflation has also disappointed lately. In April, the core rate excluding energy and food even fell from 1.0% to 0.7%. Does this undermine the confidence of the Governing Council that inflation in the medium term will increase towards the ECB’s target of below, but close to 2%?
We have been emphasizing for a long time that we must be patient. It will take more time for our extensive monetary policy measures to be reflected not only in the real economy but also in inflation. Inflation is also dampened by fundamental factors. We just have to wait and stay cautious.
Which factors do you have in mind?
Look at the job market, for example. Employment is increasing significantly. But behind that there is also a strong increase in part-time employment. This has a lot to do with new technologies and it has an impact on the wage and inflation development. For many people, at the moment maintaining their jobs is more important than raising wages.
But the confidence that inflation will rise towards the 2% in the foreseeable future, is unbroken?
There are temporary factors that currently dampen inflation, and there are fundamental factors that may fundamentally change the inflation process. Nevertheless, inflation should increase in the foreseeable future and rise towards the 2% in the medium-term.
How would you describe the risk scenarios surrounding this outlook - is there more chance that inflation will be lower than expected given recent data, or is there the possibility that it will be higher, perhaps because of the unexpectedly strong rise in oil prices?
We have to wait for our new projections in June. As things stand, however, the risks to the inflation outlook appear more or less balanced.
The International Monetary Fund (IMF) warns against the danger that inflation in the future may suddenly rise more sharply than previously expected - which could force central banks to make a quicker turnaround than currently expected. Can you also imagine that for the euro area?
No, I do not see that for the euro area. I think we will live in a low inflation environment for quite some time.
But can the ECB in the long-term allow itself to look only at inflation, given the risks of a persistently ultra-loose monetary policy, for example for financial stability?
We have a clear mandate and that is price stability. We have defined price stability as an inflation rate of below, but close to 2% in the medium-term. That must be the guideline for all our actions.
In the past, you signaled that you could imagine an end of the net asset purchases (Quantitative Easing, QE), which will be conducted at least until the end of September 2018, at year-end. Is this still valid?
Yes, absolutely. An end to the net asset purchases by the end of this year seems a realistic and appropriate scenario to me given the current growth and inflation outlook.
After the recent interest rate meeting, ECB President Mario Draghi said that "monetary policy per se" was not discussed at all. Can that really be? Is it not high time for a debate on the exit strategy? In the Governing Council, there is some displeasure that this discussion is not conducted.
First of all, we want to analyze exactly how the economy is doing. It is also about preventing premature conclusions and misinterpretations of market participants.
Could the decision on the future of QE already be taken at the next monetary policy meeting on 14 June?
I would not want to focus too much on June alone. We have several options for making a decision before the end of September.
Would the meeting on September 13th also be an option or would that be too late?
For central banks, clarity and predictability are very important features, especially in times of uncertainty. We should avoid any surprises in our steps - and thus prevent unwanted market reactions.
With the end of the net asset purchases the Governing Council must also decide how to shape its outlook, the forward guidance, for the key interest rates. So far, all that is said is that interest rates will not rise until "well" after the end of net purchases. Will this "well" then be specified?
If we decide to end the purchase program, we also have to say something about the future of the key interest rates. That's very clear. We must then look if and how we can substantiate this. But at this particular stage the next step is the decision on the purchases.
Many market players interpret this "well" in a way that six to nine months will be between the end of QE and a first rate hike. Is that right?
I know that markets have that expectation. As things stand, I would call that expectation logical and appropriate.
Could the Governing Council also explicitly include such a time horizon in its forward guidance or would that go too far?
Monetary policy needs flexibility to respond to developments. But flexibility must not mean uncertainty. We need a middle way between the necessary flexibility and sufficient clarity, for example with regard to the time horizon. We should also take into account the experiences of other central banks.
As a first step could the deposit rate be raised from the current - 0.4% alone or will in any case all three ECB key interest rates be raised at the same time?
These are very important decisions and before we say anything, we have to discuss this internally. I do not want to speculate.
For the more distant future, market participants expect the ECB to follow the US Federal Reserve's example and raise the key interest rates a few times before stopping the reinvestment of expiring QE paper. Bundesbank President Jens Weidmann has now said that there is still no commitment to that.
That’s absolutely right, that’s not a done deal yet. We simply had no discussion about it. But I see a certain logic in following the example of the Fed, and in my reading our previous communication also points in this direction.
The ECB is acting very carefully. In case of doubt, is it better to be too careful and to wait too long to exit than to get too fast and too early?
We need to find the right time and the right pace for normalization. In any case, we are not too late and not "behind the curve" as some critics accuse us.
But is a monetary policy, which is more expansionary than at the height of the global financial crisis, appropriate given growth above potential and inflation rates of between 1% and 1.5%?
Our current monetary policy is the right one. There is no doubt for me at all. The most important thing right now is patience and predictability. That's why I would not want to change anything at all at the moment.
Does the continued high level of indebtedness of many euro area countries pose a problem for the future normalization of monetary policy?
It is frustrating that some euro area states have not used the time we gave to them and the good economic situation to reduce their debt and deficits. Of course, as an ECB, we do not live in an isolated world but our primary task is monetary policy for the entire euro area and our primary mandate is price stability. These are the principles we follow.
There is also a lack of progress in reducing bad loans, the non-performing loans (NPLs).
All in all, the situation has improved significantly for the euro area as a whole. But there are still big differences between countries. The stock of NPLs is still too high in some countries and that is a problem. The affected countries know this and they will tackle the problem. The ECB’s banking supervision arm SSM is also exerting pressure.
Does it require stricter rules of the SSM for the stock of bad loans, similar to the ones for new NPLs? The SSM had announced that, but that has been delayed, and finally there were reports that this project could be dropped altogether.
I am a friend of stricter rules. This is also based on our experience in Lithuania. At the height of the crisis, the share of NPLs was 20%. Today it is 3%. We have tackled the problem very consistently and have raised the rules for provision for NPLs significantly. Of course the situation is different in every country. But you solve the problem only by actively approaching it. The problem does not disappear by itself.
The ECB is calling for a "quantum leap" in the integration of the euro area, but currently, not much is happening. Not least Germany and France disagree. How much does this frustrate you?
It is currently a very good time to solve problems. These include too high a debt and this includes weaknesses of the monetary union. It would be fatal if we did not use this opportunity. I am thinking of the capital markets union, the completion of the banking union or the harmonization of insolvency law. These are areas where progress is needed. In the end, it is also about the position and competitiveness of Europe in the world.
Does the banking union in any case require a common EU deposit insurance? In Germany there is great resistance against that.
A fully operational and effective banking union requires a common deposit insurance. I also cannot always understand the arguments to postpone that. I understand the desire to reduce risks before there is risk-sharing. But that could happen in parallel. We could agree on certain steps towards a common deposit insurance conditional on certain progress in risk reduction. We have to make progress on the subject.
Does it also need a euro area budget or a euro area finance minister?
A euro area finance minister, above all, would be symbolic. But I'm more looking for substance. In fiscal policy, more centralization would be good for Europe. Take a look at how the US has developed. Of course, Europe is different. But in the economic sphere, we could do more together - and achieve more together.
And without progress, the ECB will remain as the only actor in the next crisis - as "the only game in town"?
We are used to that. But seriously: Each and every actor has to fulfill his duties. Otherwise the European Union will not remain attractive in the long run.
In the ECB, there are considerations for a new liquidity aid for banks in liquidation. Do you think that's a sensible idea?
We have a good framework in Europe for dealing with troubled banks. I would not want to change that in principle. However, there are certainly opportunities for improvement, for example in the exchange of information between SSM and the EU Banking Resolution Board SRB. Another issue is the temporary provision of liquidity. This can cause problems and for that we have to find a solution in Europe. We are discussing this in the ECB now. I am open to this debate. We are facing new realities and we have to face them openly.
Are there also any "new realities" for monetary policy? Is it necessary to rethink the widespread 2% inflation target, the inflation targeting itself or a mandate for financial stability?
For us as central bankers, it would be premature to discuss possible changes now. Now it takes an intensive analysis to better understand what happened and what's going on. In the future, however, it may be appropriate to put things to the test. The ECB reviewed its strategy and the 2% target in 2003. That can be a model for the future.
And unconventional measures such as negative interest rates and broad asset purchases could also be the new standard in the future?
It is also too early for a judgment on that. But in the end it is possible that this will be part of the new reality too - why not?
Could the independence of central banks also be put into question in the future?
I do not expect that. The independence of the central banks is a high asset and indispensable.
What do you think of the idea that central banks will in the future issue digital central bank money to everyone? The Lithuanian central bank is quite advanced in such innovations, as evidenced by the project of a digital coin for collectors?
New technologies like Blockchain offer a number of new opportunities and we also see them as an opportunity to democratize the financial system. As far as digital central bank money is concerned, we should look at it. Other central banks, in Sweden or Norway, are more advanced and there is no reason why we should stay behind. Of course, many questions are open and it can mean serious changes - but we can not and should not completely ignore innovations.
The interview was conducted by Mark Schrörs.
8th of May 2018
Vitas Vasiliauskas is Chairman of the Board of the Bank of Lithuania and Member of the Governing Council of the European Central Bank (ECB).