Interview with Ardo Hansson, Governor of Eesti Pank and Member of the Governing Council of the European Central Bank (ECB)
"We have to be alert"
Mr. Hansson, is inflation dead?
No, definitely not. Of course, we all face a certain puzzle: The economy in the euro area, for example, is currently incredibly strong and even growing above potential. The output gap closes this year and unemployment has fallen sharply. Nevertheless, we see not much stronger wage growth and not more inflation. But inflation is certainly not dead. It would be dangerous to assume that.
But many market participants and also some economists seem to think so. They are betting that inflation will stay low for a long time or even eternally. So they are wrong?
In recent years, there has been a whole range of factors that have dampened inflation - and nothing that has fueled inflation: Many countries have fiscally consolidated, businesses and households have reduced debt, and there have been labor market reforms. Added to this there was the rapid decline in oil prices. And finally, there were factors such as globalization and digitization. Worldwide we see a similar picture in the other developed countries. But these factors will not last forever.
So, inflation is about to make a comeback?
I am firmly convinced that the laws of economics continue to apply and that this also applies to the relationship between the utilization of an economy and the wage and price trends - the theory of the Phillips curve. It only takes a little longer this time until strong growth causes prices to pick up - also in the euro area. We must not despair. We just need more patience.
Has a turning point already been reached? Will inflation be the big surprise in 2018?
As far as the euro area is concerned, we expect a gradual increase in inflation over the course of the year - not a sudden sharp increase. We already see a positive inflation trend in the details, even if this is not very strong. Wage growth is still moderate. But you hear more and more complaints about labor shortages. That will sooner or later be reflected in wages.
Would you say that the risk of higher inflation than expected is currently greater than the risk of it being lower?
That is hard to say. There are certainly upside risks. Price pressures are building up under the surface. It is hard to predict when this will break through. Of course, the big concern is that there is a sudden increase in wage and inflation dynamics. There can be non-linear developments. Then we would be forced to adjust our policies very quickly. That's why we have to be alert. But of course, there is also the possibility that the dampening factors will remain so strong for the time being that even the gradual increase in inflation will not occur.
In December, core inflation excluding energy and food remained at 0.9% instead of rising as expected. How big is the disappointment?
Monthly figures are not decisive for us. We will not get distracted by that. But if there was no meaningful upward trend in the underlying price pressure over say three to four months that would be disappointing. On the other hand, if we saw more evidence of a material increase of price pressures, it would allow a further reduction in the degree of expansion.
ECB President Mario Draghi has recently stressed that there is growing confidence in the Governing Council that inflation is sustainably heading towards the target of below, but close to 2%. Did the December data change anything in this assessment?
No, that does not change that much. This growing confidence is based above all on the strong development in the real economy: The sentiment is the best for 18 years. Growth is increasingly broad-based across countries and sectors. The situation in the euro area is even better than in many other regions. In addition, there is currently no longer the danger of deflation. For many this danger was the main motivation for the asset purchase program. And finally, inflation expectations are picking up again. Inflation is not yet where we want it to be - but everything else looks very good.
Economic sentiment has reached levels at which the European Central Bank (ECB) raised interest rates in previous cycles. In contrast, the ECB's Governing Council even extended Quantitative Easing (QE) until the end of September 2018, albeit with a reduced monthly purchase volume.
If we were to look only at the economic situation and that was our benchmark, we would certainly be reducing our monetary support even more. Then we also should not be there where we are currently in terms of interest rates. But when we look at inflation, we have to say that we have not reached our goal yet. So there is good news and bad news. In the synthesis, our assessment is that a broadly accommodative monetary policy is appropriate. Some in the Governing Council say it could be a little less, and others say, it could be a little more. But there is no one saying we should do much less or much more.
But is the ECB not already lagging behind – that means "behind the curve"?
All in all, our monetary policy stance is broadly appropriate. The level of interest rates, the volume of purchases - that fits. It should not be forgotten either: We halved our monthly purchases to € 30bn only in January. We have to let that work now and not immediately question it again. However, there is a need for action in our communication. It is very important and part of the monetary accommodation. We now have to think and discuss intensively how we are gradually changing our communication. However, a lot has already happened: Our statement on our decisions today looks different from twelve months ago.
Two key things have not changed: the one-sided promise to do more in an emergency, the “easing bias”, and the direct link between the QE net purchases and the 2% target.
There are certainly good reasons to reduce the importance of the net purchases in our communication soon - also with a view to a potential end to these purchases. The "easing bias" is historically justified: When we reduced the QE purchases for the first time, at that time from 80 billion euros to 60 billion euros, we wanted to give a kind of reassurance that the tendency was more to do more and not even less. But the fact that an option is not mentioned does not mean that it is fully off the table.
That means, in spite of the one-sided promise, the Governing Council would have enough flexibility to tighten monetary policy more quickly if necessary?
We are free and flexible at all times. If things were to evolve completely differently than expected, it would be weird if we did not react. This is true in both directions. What is very important: We always talk about intentions, not promises. Our forward guidance is not a rigid pre-commitment.
Is it enough to adjust communication in summer?
I would say it would be better to do that before the summer.
If growth and inflation is evolving as expected, will the QE extension in October 2017 be the last one?
It's too early to make predictions. As I said, the real economic indicators are currently even stronger than we expected, but the inflation figures are somewhat weaker. However, if growth and inflation is evolving more or less in line with the projections, it would certainly be conceivable and also appropriate to end the purchases after September. Why not? According to the projections, inflation will rise to 1.8% in the second half of 2020. One should also not forget: The better the economy performs, the more expansive an unchanged loose monetary policy becomes - the more stimulating it will be. The fact that the euro economy is doing so well suggests that the monetary policy support should be cut back gradually.
And if so, is there a need for a phasing out of the purchases, a "tapering", or is it possible to go from 30 billion euro to zero in one step?
We have reduced our QE purchases in two major steps, from € 80bn to € 60bn and now to € 30bn. These were significant changes. That did not cause turbulences in the markets and that is very encouraging. The last step to zero is not a big deal anymore. You do not have to do a lot of fine-tuning. I think we can go to zero in one step without any problems. Compared to the stock of bonds in the central bank balance of about 2.5 trillion Euro a few months with an again reduced purchase volume would not make a big difference.
Recently, the euro has appreciated again. Could an appreciation of the euro postpone the QE end into the future again?
The strength of the euro is first and foremost a result of the strength of the euro economy. That's good news, also with regard to inflation. The stronger the growth, the sooner inflation should pick up. On the other hand a euro appreciation tends to dampen inflation. But these effects should more or less balance each other out. Up to now, the appreciation of the euro is not a threat to the inflation outlook and does not change our view. You should not overdramatize that.
You have warned against waiting too long to exit the ultra-loose monetary policy. What are you particularly afraid of?
It would be dangerous if we fell "behind the curve". Because then we might later have to act suddenly and reduce our support very quickly, to get back “on the curve”. That's my main concern. This could cause problems for banks and the economy as a whole and lead to a more turbulent re-pricing of assets. A timely, gradual exit is much better. So I do not like if people argue for erring on the side of caution. That sounds natural and rational, but it is ultimately a form of imprudence.
The Governing Council will consider hiking interest rates only “well” after the end of QE net purchases – the "sequencing". In the US, it took 14 months between the end of QE end and the first rate hike. If that is transferred to the euro area that would mean that even if QE were to end after September 2018 immediately, interest rates would not rise before the end of 2019. Would that be "behind the curve"?
So far, in the Governing Council we have not quantified what "well beyond” means. Different colleagues may have different ideas. But we have to face this question in the future. But it would be wrong to quantify this concretely, with x months. That would bind us too much and restrict us. However, the sequencing is extremely important because it reduces uncertainty.
The US Federal Reserve also had a second sort of "sequencing": It raised the key interest rates a few times before it began to actively reduce its central bank balance sheet. Is this also a role model for the ECB?
We have not yet finalized the exact details for the later years, it is too early. However, it makes sense for me to follow this example and raise the key interest rates a few times before starting the reduction of the balance sheet. I also think you can read our current communication in the sense that the reinvestment of maturing bonds will last longer than the key interest rates remain unchanged.
Now there is the halving of the net purchases to 30 billion euros. This is primarily to the detriment of the purchase of government bonds, so that the relative share of acquired private bonds increases. You prefer to buy corporate bonds from government bonds. Why?
First of all, in the end, it's all about what the market sells - that's crucial. As for your question, any monetary policy has risks and negative side effects. For me as a central banker, policy effectiveness is what matters. I think it is better to channel money directly to companies and the real economy via such purchases than indirectly through the purchase of government bonds. I am also worried that the negative effects on states are much greater than on companies. The "zombification" of governments is more worrying to me than the "zombification" of companies.
What do you mean exactly?
Companies as well as banks regularly prepare themselves for different interest rate levels and are more willing and able to take uncomfortable measures. For states this is less the case because of political cycles. Many governments underestimate that the currently low interest costs are also due to monetary policy, and that this is not a permanent trend. So far they have not used the leeway created and the debt ratios are too high. On average, it is around 90% in the euro area. Many states are badly prepared. If interest rates rise again, it can lead to a rude awakening.
This is precisely the reason why some people are saying that the ECB will never again be able to raise interest rates because that could bring back the euro crisis.
We cannot run our policies based on individual countries. That must be clear to everyone. We have to show strength there. For some countries, a turnaround on interest rates will certainly be a huge challenge. But we cannot take that into account - our mandate is price stability.
How do you assess the political situation in general? The crisis in Catalonia, the tenuous formation of a government in Germany, the uncertainty surrounding the election in Italy – does all that pose a risk to the euro area economy?
Such risks have been with us for quite some time. Brexit, the elections in the Netherlands and France - it was always said that when this is over, everything will be fine. And then there were always new risks on the horizon. For us as the central bank, they are part of the overall picture. But again: We can and we will not react with our policies to the political situation in individual countries. On the positive side, the resilience and capacity of the euro area economy to absorb shocks is much greater today than it was years ago. The economy today can withstand some political turmoil without much damage.
Recently warnings have increased that the world may already be heading towards the next financial crisis, also as a consequence of the ongoing flush of central bank money. Do you see such a danger?
The rally on the stock markets in some economic regions is surprising. The higher you fly, the greater the risk of a fall. But whether the share prices have already decoupled from the fundamental situation, I dare not judge. If interest rates are historically low, it is not very surprising that stock prices, for example, are at historically high levels. In the euro area as a whole we currently see no major exaggerations or dislocations. But it is also clear: Over time, the risk of bubbles increases and we as ECB must be very vigilant.
Do many market participants rely too much on a continued loose monetary policy?
I was more worried about that a year ago. Today, many central banks are on a normalization path. We too, as the ECB, are on such a course - regardless of whether you call it normalization or recalibration. Nevertheless, stock prices are rising. So there must also be other driving factors than the central banks.
How worried you are about the rapid rise in the value of Bitcoin and other cryptocurrencies - is there any risk to financial stability?
What is currently going on in the whole world of cryptocurrencies is completely crazy. This is a real bubble - a bubble that may be worse than the tulip mania in the Netherlands in the 17th century. There is even less inherent value in a cryptocurrency than it is in a tulip. But I currently do not regard that as a risk to financial stability. The volumes are too low. If they rise sharply and loans are raised in a big way to massively buy such assets, then it could be a danger. Currently, however, it is a problem for investors and consumers. Some people will probably make a lot of money. But many people will probably lose a lot of money too.
In Estonia there are also such considerations - the Estcoin.
There were unfortunately some misleading reports and comments from government agencies. To put it bluntly, neither the government nor we, as a central bank, are considering introducing a cryptocurrency. Our currency is the euro, and the euro is a good currency. Once this whole bubble bursts, this discussion will have settled. We will not do anything that anyone has to worry about.
Finally, again to the ECB: You are considered a hardliner in the Governing Council, a "hawk". Would you be pleased if in 2019 another representative of this camp - Bundesbank President Jens Weidmann - would succeed Draghi as ECB President?
It's always nice to have people around you who see the world much as you do - that's human. From my personal perspective, that would be positive. But at the end of the day I'm not the one who makes that decision. More decisive is something else: There are now a number of changes. It is important that this is addressed timely and that we get good, competent and politically independent experts.
Do you think that the ECB policy in the past few years under a President Weidmann would have looked much different?
The Governing Council has 25 people sitting at the table and most decisions are made consensually. So, monetary policy is not a one-man-show. But of course, the president sets the tone - and that has a big impact.
The interview was conducted by Mark Schrörs.
Börsen-Zeitung, 15th of January 2018