Interview with Luis de Guindos, Vice-President of the ECB, conducted by Miquel Roig and Jorge Zuloaga on 26 August and published on 1 September 2021 |
You are almost halfway through your term as Vice-President of the ECB. How would you assess your term so far, and what aims do you have for the second half?
These three years have been extremely interesting, and they have been marked, above all else, by the pandemic – an extraordinary event that has sparked an enormous health crisis. It had an extremely severe economic impact in a short space of time, which required an unprecedented economic and monetary policy response. The next 18 to 24 months will be defined by attempts to leave the economic consequences of the pandemic behind us and to minimise its structural impact. That will be the main objective.
I thought you might be a little more optimistic, but it seems you are happy with mitigating the consequences and going back to where we were before.
Some of the short-term impact has been successfully mitigated, but the pandemic will have had structural effects on the European and world economies. The fiscal effects will be the most apparent, with the euro area’s average debt-to-GDP ratio 20 percentage points higher and more pronounced structural deficits. There is also other scarring, which could be structural, in the job market, as well as greater inequality between advanced and emerging economies. The pandemic has had a greater impact on small and medium-sized enterprises, low-income workers and women.
In such an environment, do you think the economy is ready for a gradual withdrawal of asset purchases?
I was talking about the medium term in what I just said. The ECB’s primary response to the crisis consisted of action in three different areas. The first focused on liquidity, through the targeted longer-term refinancing operations, or TLTROs, supporting banks’ credit provision to households and firms. The second focused on asset purchases through our emergency [purchase] programme. And the third focused on changes in the field of banking supervision to enable banks to free up capital and increase their lending capacity. These measures were crucial to averting a debt crisis. Bond market fragmentation has been avoided, and we have ensured that financing conditions remain favourable. Future monetary policy decisions will essentially depend on how the economy and inflation develop in the coming months.
But with that in mind, is it not too early to determine whether or not the European economy is ready for the emergency purchases to be withdrawn?
The monetary policy measures were intended to limit the impact of the pandemic on the economy, maintain favourable financing conditions and ensure we met our inflation target. Looking at the European economy, you can see that the recovery was very strong in the second quarter, and we believe it will continue to be fairly strong in the third and fourth quarters. Our emergency [purchase] programme is linked to the pandemic and its economic consequences. But one thing is clear: recent data are very positive. The European economy will be able to recover its pre-pandemic income levels by the end of this year or the beginning of next year. We will have new projections in the coming days and will take our decisions accordingly. In September we will also have to decide on the volume of purchases for the last quarter of this year. If inflation and the economy recover, then there will logically be a gradual normalisation of monetary policy, and of fiscal policy too.
Up until now, you have said that we would reach pre-COVID income levels in the first quarter of 2022. Is it the improving economic forecasts that are now leading you to say this could happen by the end of the year?
It is a nuanced issue – we are talking about just a few months. The economy is performing better in 2021 than we expected, and this will be reflected in the projections that will be published in the coming days. The leading indicators are positive, and in the coming days we will see the actual figures. The main uncertainty was the impact the Delta variant would have. What we are seeing is that it is not having as great an impact as we projected four months ago. This is mainly because governments have responded with fewer restrictions on economic activity than we had anticipated.
Does this improvement in the projections also apply to Spain?
The Spanish economy shrunk by 10.8% in 2020, more than any other euro area economy. So it should logically experience a stronger-than-average recovery. A country’s economic development during the pandemic should be assessed in terms of when it recovers its previous income levels.
What are your expectations for inflation growth?
Inflation will continue to pick up in 2021. Our baseline scenario is that it will fall back in 2022. We have to check that there are no second-round effects, because that would mean this temporary impact would become structural.
What is the ECB’s assessment of the measures governments have taken to soften the impact of the crisis? Did they get it right, or have they gone too far?
In terms of fiscal policy, governments acted in a very similar manner. First, they provided public guarantees, so credit continued to flow. Second, they granted moratoria, which have also had a positive impact. And third, the temporary layoff schemes that have been introduced in various countries have also been very effective. These measures have taken the sting out of the crisis, the impact of which has been greater on GDP than on employment. In Europe, GDP fell by 7%, but employment by just 2%. However, if we look at the figures for hours worked, the fall was greater.
Were any measures missing? Or do you maybe think some measures went too far, like public borrowing?
The measures were appropriate. The rise in the debt-to-GDP ratio was inevitable. Significant action was needed in the realm of fiscal policy. The alternative would have been worse. And at the European level, this time there was a response that stood out: Next Generation EU. European funds, if used well, will be crucial to the recovery.
With the worst of the pandemic over, should steps now be taken to reduce public debt and correct the deficit?
The premature withdrawal of stimulus should be avoided given that the economic situation is still fragile. Some measures are being gradually withdrawn, such as temporary layoff schemes, debt moratoria and loan guarantee schemes. In that respect, we are seeing how fiscal measures are starting to adjust to a certain degree of normalisation. The withdrawal should be prudent, while also avoiding leaving measures in place for too long leading to the creation of moral hazard or the zombification of the European economy.
Nobody is saying that adjustments won’t be necessary, but there are two schools of thought: one is in favour of starting to talk about them already, while the other would prefer to put it off until later. Which do you most identify with?
Once the pandemic and its effects are over, countries are going to find themselves with higher deficits and, more importantly, with much higher levels of public debt. Once the effects of the pandemic are behind us, credible budgetary plans will be required. It will be up to the European Commission to set the pace in this area, since this is a fiscal policy issue. The general escape clause will apply next year, but once pre-pandemic income levels are reached, the Stability and Growth Pact will once again be taken into consideration.
Although fiscal policy is the European Commission’s responsibility, are you not afraid that this increase in public debt could once again raise the issue of the link between sovereign risk and the banking sector?
The pandemic has brought about an increase in budget deficits and debt-to-GDP ratios. It has also led to greater divergence between countries. Those with a debt-to-GDP ratio higher than the European average will have to make a greater effort to rectify this situation through a credible budgetary plan. It’s that simple. The European Commission will decide on the exact form, and in any case, any plan must be implemented gradually and cautiously.
At the start of the crisis, one of our main concerns was the risk of a “doom loop”, i.e. the interconnectedness of firms, banks and sovereigns and the risks that could arise from it. Fortunately, these risks did not materialise. The non-performing loan ratio has continued to fall, it has not had an impact on bank balance sheets and credit did not dry up, which would have made the economic situation worse. And this occurred thanks to the fiscal policy measures, the debt moratoria, the government loan guarantee schemes, the liquidity we have provided to banks and the fact that the ECB’s actions have ensured that financing conditions remain favourable.
This is the negative link that has been avoided and that we must continue to avoid. How can we do this? By withdrawing stimulus gradually. There must first be an economic recovery before monetary policy and fiscal policy can return to normal. But obviously we will not always have emergency programmes, since that would mean that we had not put the pandemic and related costs behind us.
All of the ECB’s actions have contributed towards eliminating these negative links. But its actions carry risks as well as benefits. For example, the more stimulus there is, the more difficult it is to withdraw. How dangerous an obstacle is this?
Withdrawal of the extraordinary stimulus measures should be aligned with changes in economic activity levels. If things start to return to normal, as is currently the case, the extraordinary measures will have to be gradually withdrawn. We should monitor economic developments, inflation and economic projections. We will analyse upside and downside risks, then make a decision. We rely on the data. At the end of 2019, before the pandemic, the ECB had its monetary policy and governments had their fiscal policy. When the pandemic is over, we will have to return to using the economic, fiscal and monetary stimulus measures that correspond to a normal economy. We are not there yet, but we are gradually and continually moving towards that point.
The Bundesbank recently renewed its criticism of the ECB’s ultra-loose policy. In the current climate, does this stance worry you?
In a very high percentage of cases, the ECB’s monetary policy was adopted unanimously. This was the case for the pandemic emergency purchase programme. Different points of view do of course exist; there are 25 of us on the Governing Council. Sometimes we take decisions unanimously and other times with a large majority. The strategy review, for example, was adopted unanimously.
We wanted to ask you about that. Some say it is a missed opportunity, others that it goes too far. Do you think it will still be around in another 20 years?
I wouldn’t dare make forecasts for the next 20 years. Besides, we have said that the Governing Council intends to assess periodically the appropriateness of its strategy, and the next assessment will take place in 2025.
But do you see signs that the market thinks that the ECB will be more tolerant about inflation?
It’s not a question of being more tolerant. We have changed the definition of price stability, but that doesn’t mean that in general we will accept a much higher rate of inflation. We have set our target based on a logical development. The inflation target is now 2% over the medium term and not “below, but close to, 2%”, as it was before. That’s not revolutionary. We continue to be fully committed to price stability.
But the definition is more tolerant.
Yes, but that’s a marginal issue. We have said that our target is symmetric, meaning that any negative or positive deviations from the 2% target are equally undesirable. This is important because up until now, the perception was that the ECB acted more forcefully when inflation overshot the target. But we’re not like the Federal Reserve System and we don’t accept inflation compensation. What we have said is that inflation can be temporarily and moderately higher than 2% because current interest rates are zero or close to zero. But that does not mean that in general we have raised our level of acceptance of high inflation.
One of the risks of monetary policy is the development of bubbles in assets such as real estate, which has continued to increase considerably in Spain. Do you see a risk of overheating?
There are certain sectors in the European real estate market, such as residential real estate, where we are seeing prices rising and which we are therefore monitoring. These cases of very specific sectors, which are nevertheless starting to become more common, have to be addressed through macroprudential policy. Monetary policy is not the appropriate tool because it cannot differentiate in that regard.
And, in your view, have the conditions been met for macroprudential buffers to be activated in certain countries?
There were some countries, like Germany or France, which had taken measures such as activating the additional capital buffer. But they deactivated it when the pandemic hit, which makes sense. Once things return to normal, it would also make sense to take measures of this kind if there are instances of overheating.
There have been quite a lot of mergers in Spain. When you were a minister you worked with the idea of there being fewer banks. Do you think there is still scope to work along these lines?
The context is one of low profitability in the banking sector, and consolidation is a tool that can be used to improve profitability through cost savings. But it is a tool and not an end in itself. It’s the market, not the ECB, that takes decisions about bank consolidation. What the ECB has identified – in Europe, not just in Spain – is an environment of low profitability. This has now improved because the level of provisioning hasn’t been as high as it initially might have needed to be. From the structural perspective, Europe is facing a situation of overcapacity and excess costs. And consolidation is a tool that can be used to bring about improvements in those areas.
And in this context of overcapacity and the need to improve profitability, what are your views on the debate in Spain about bank redundancies? Could it get in the way of the improvements needed in terms of profitability?
As ECB Vice-President I can’t comment on that kind of domestic matter. In general, bank consolidation is one of the methods that can help to improve profitability. This sometimes means making adjustments, which can be painful in the short term. But if the adjustments are not made, there’s the possibility of a crisis. Moreover, bank profitability is not only a medium-term problem. It has implications for banks’ ability to generate capital now, and it even ends up affecting their lending capacity. Of course, we must think about measures that might minimise the downside of the necessary adjustments. But, if nothing is done, over time that low profitability ends up becoming a much more structural crisis.
Following the controversy surrounding [the asset management company] Sareb, would you change anything from the 2012 bailout?
The bank bailout allowed Spain to grow [at a rate] above the European average for years and has made it easier for Spanish banks to face the stress tests and the crisis with sufficient levels of solvency. Having said that, there is always room for improvement.
During the latest round of earnings announcements, the banks have been clear that current provisions are more than sufficient, and some even see the right conditions to start releasing some, which goes against the ECB’s message. Have the banks won the battle with the supervisor?
It’s not a matter of battles. A wave of corporate bankruptcies, as was feared in March or April last year, has been successfully averted. But the fact that developments in non-performing loans lag behind economic developments must be taken into account. And this is particularly true in the current circumstances, when there have been moratoria and government guarantees. The current low levels of non-performing loans don’t appropriately reflect what might happen in the coming months. Non-performing loans are going to rise. So from the financial stability and supervisory perspectives, caution is the best approach. Banks will have to adjust those provisions to an increase in non-performing loans due to the significant time lags. The “fallen angels” situation has been avoided, but that doesn’t mean that there won’t be an increase in non-performing loans in the coming quarters. And if that happens, provisions will have to be adjusted.
Despite all the attention the ECB has given to stopping reputational issues in the banking sector, they are still very much present, at least in Spain with cases like Villarejo. Does it worry you that there is no end to such cases?
A bank’s main asset is its reputation. The banks themselves have the greatest interest in their reputation being spotless, since their credibility and business depend crucially on the trust that is placed in them.
Compliments of the European Central Bank.