There is a great deal of anticipation on the markets and in general looking ahead to the ECB’s December meeting. What can we expect from it?
We should expect what the President stated very clearly at the last press conference: that the ECB’s Governing Council will reassess the macroeconomic outlook and recalibrate its measures accordingly. The outlook for inflation has clearly deteriorated rather than improved over the past few months owing to the resurgence of the pandemic and the containment measures taken in response. It’s also clear that our stimulus so far has not been sufficient to make progress towards our aim in a sustained way. In spring we reacted quickly and we should do so again. The consensus within the Governing Council is that our instruments need to be recalibrated in December.
When you talk about recalibration, what do you mean exactly? Are you referring to an increase in the rate of monthly asset purchases or the use of new instruments?
This is a collegial decision taken by the Governing Council. But it’s useful to think about our policy in two ways. The euro area has suffered a huge economic shock, with considerable downside risks that have threatened to set self-reinforcing recessionary and deflationary dynamics in motion. Our forceful policy response since March has first of all been designed to stem these downward spirals and allow financial markets and ultimately the economy to withstand the shock, thereby supporting price stability. This will remain the case for as long as necessary. The second element involves calibrating our stance to reflect our commitment to bring inflation back to our aim. We must do this without undue delay, in order to eliminate any possible question marks over our determination to preserve price stability – our primary mandate – and to avoid a disanchoring of inflation expectations: with the second wave, some of the downside risks have materialised and the starting point for the inflation outlook is now lower than a few months ago. In this endeavour we are data-driven: at our last meeting, we decided that it would not be wise to take a decision before understanding the extent of the new containment measures, their impact on the economy and the fiscal measures that governments would take in response.
Does the ECB still have the firepower to deal with this second wave of coronavirus?
Dealing with the second wave is all about the right policy mix. Research shows that when private sector demand is constrained by uncertainty and health restrictions – as is the case today – fiscal policy is key. Favourable financing conditions create the best environment for an effective fiscal policy, which in turn creates the conditions for the private sector to also take full advantage of the favourable financing conditions we ensure through our measures. In other words, fiscal policy in this phase has become an important channel for transmitting our monetary policy impulses and supporting our stabilisation goals. Seen from this perspective, there’s a lot more we can do through a combination of our asset purchase programmes and our measures to support the financing of the real economy through banks and the bond market. And there should be no doubt as to our commitment to bring inflation back to our aim and therefore the continuity of our policies even when the recovery gets underway. We want to see inflation converge towards our aim in a sustained manner and we cannot hesitate in taking decisive measures if we wish to avoid the risk of a downward adjustment in inflation expectations. We have firepower, we have instruments that we can recalibrate, and we’re going to do so.
Are you concerned we might fall back into recession?
I am concerned. There has been some good news, such as the announcement of the possible approval of vaccines by health authorities. In this respect, there is light at the end of the tunnel. But even under the most optimistic scenario, the production, distribution and administration of these vaccines will take time. It may take even longer to reduce the risk and the perception of risk among the population: savings intentions are at a record high, households and businesses are more indebted than one year ago and coronavirus-induced uncertainty has the potential to leave scars even after the economy recovers. In other words, 2021 will still be a “pandemic year”, and we will still have to tread very carefully. We cannot be complacent. We cannot take the risk of adverse interim scenarios and of letting the consequences of the pandemic last longer without introducing additional policy stimulus, otherwise our production capacity will be hollowed out in the process. The recovery would then take even longer and inflation could continue to hover at very low levels.
The markets were ecstatic following the vaccine announcements. Do you feel there has been too much optimism on show?
Financial markets are forward-looking by their very nature. Based on the new information available and their interpretation of it, they take a view on the future trajectory of the economy, corporate earnings and dividends – which by the way reflect assumptions about policy support. But in our role as central bankers, we must be prudent. We need to base our decisions on the various scenarios that could materialise in the absence of our intervention. And we cannot take it for granted that things will go as well as expected by financial markets. We cannot afford to be too optimistic. The risk of adverse scenarios – and the damage they could cause – is simply too great. And even in the optimistic scenario, inflationary pressures are likely to remain subdued and to recover very slowly.
Do you think that governments and the European Commission, as well as the ECB, should also be prepared to do more if the crisis persists or is more serious than expected?
Governments are aware of the need to intervene and all the conditions are in place for governments to act. Financing conditions are favourable, we have been clear that we would ensure that they remain favourable, and our forward guidance makes our commitment explicit. Moreover, European authorities have already reacted strongly: the Next Generation EU (NGEU) programme will support the recovery and other instruments have already been deployed, such as the European Commission’s instrument to help Member States protect people’s jobs during the pandemic. I have no reason to doubt that additional efforts will be made if necessary. Governments have confirmed this, including those previously reluctant to take part in common responses. We have seen a forceful, timely, European policy reaction to support European people and businesses in response to a common shock. And it is working well.
In some countries, such as Portugal, the fiscal stimulus is relatively limited because of high public debt levels. Do you agree with this more cautious approach or do you think that governments should be more expansionary?
Fiscal policy throughout the euro area has been expansionary, although more so in some countries than in others. Substantial discretionary stimulus measures have been taken across the board. We should not look at these measures on a country-by-country basis as the spillovers from a forceful synchronised and common fiscal response are large. Moreover, the efficacy of fiscal policy – the so-called fiscal multiplier – increases when interest rates are close to their lower bound. And like in the United States, we have seen a decisive, area-wide response in terms of both fiscal policy and monetary policy.
Isn’t there a risk that some countries, such as Portugal, Spain or Italy, will get left behind in the recovery since they have less fiscal space to respond?
We cannot rule out that possibility altogether. But compared to the previous crisis, we have a very different set of solutions in place. Even countries with high debt to GDP ratios, whose response was weaker in the past, can now take advantage of the resources made available at the European level. What is now crucial is that countries use those resources to finance investment and boost their growth potential.
What should Portugal’s priorities be?
Every country has its own challenges. But a number of cross-cutting themes also apply to Portugal. The priority should be investment to facilitate the reallocation of production and jobs to the sectors with the highest growth potential: investing in activities that improve the quality of the environment and the country’s technological and digital infrastructure, activities that create a knowledge-based economy building on human capital and education. These are also the priorities identified by the Next Generation EU programme.
In any event, the debt levels of many countries will hit new highs. David Sassoli, President of the European Parliament, recently spoke about the idea of making the recovery fund permanent, of having European debt and even of debt forgiveness. What do you think of these ideas?
The move towards deeper European integration is highly desirable. It’s a natural development of monetary union. We should bear in mind that, following the approval of the NGEU this summer, euro area countries have taken a big step towards closer fiscal integration. They have also created the legitimate expectation of a common fiscal response when dealing with a common shock in the future. I don’t know how long it will take to make even greater progress. It is my hope that, when we look back in 20 years’ time, we will look upon 2020 as a turning point on the road towards European integration.
Is it possible or even desirable for there to be some form of debt forgiveness via the ECB and its public debt portfolio?
Doing so would contravene the Treaties. And we must remember that all debt is credit. If we cancel a debt, we cancel the corresponding credit and this could have broader, destabilising consequences. Only growth can protect us from debt.
Will the ECB continue to avoid country yields skyrocketing and there being any sign of debt market fragmentation?
Taking steps to avoid financial fragmentation is essential in order to implement monetary policy. We therefore introduced a new programme – the pandemic emergency purchase programme – which was more flexible than previous ones, precisely to combat any fragmentation of financial markets along national lines. But this programme also has a second role, which is to support our core price stability mandate. The economy is currently subject to lockdown measures and inflation is moving away from our objective of 2%, so we need to take action to stimulate demand and strengthen the inflation path.
What can we expect from the ECB’s strategy review?
We will review each and every aspect of the strategy. But there is not much use in speculating about the outcome while the process is still ongoing. We are involved in very complex discussions. It is a question of striking an overall balance – a typical case of nothing being agreed until everything is agreed. And we will present our final conclusions in late 2021.
But how far can the review go? Might we potentially see a new inflation objective in excess of 2%?
We will look at all elements. No specific factors will be excluded: the numerical issue of defining price stability, the instruments concerned, the interaction between monetary policy and financial supervision, the interaction between monetary policy and financial stability, the interaction between monetary policy and fiscal policy. We will be looking at everything.
Can we expect to see banks in difficulties, as was the case during the financial crisis? Particularly in countries whose financial sectors have been more vulnerable, such as Portugal, Spain or Italy.
I’d like to challenge that assumption. There are no countries that are inherently “more vulnerable”. Past experience shows that in all countries, if there is a prolonged period of recession, bank balance sheets will run into trouble as companies and households struggle to repay their loans. The outcome is different depending on how quickly countries react and what their fiscal capacity to react is. Portugal and Italy are not fiscally constrained today in the way they were a decade ago. But clearly all authorities need to work to bring our economy out of recession as soon as possible, otherwise banks will be affected. Nothing is inevitable. Our response to this crisis is entirely different from ten years ago.
Have supervisors responded differently?
When the financial crisis hit in 2008, the reaction of many supervisors was largely procyclical. This time it has been quite different. The ECB has encouraged banks to use their capital and liquidity buffers for lending purposes and loss absorption. It has introduced supervisory flexibility for the treatment of non-performing loans (NPLs). And we are discussing further potential responses at European level. Sooner or later, I would expect banks to be affected by the crisis. Whether or not it will result in a banking crisis will depend on the policies that we adopt. We are aware of the risks and are not in denial. We will continue to monitor the situation and be ready to act if things deteriorate.
Would the creation of a European “bad bank” to deal with NPLs be a good idea?
If we take the view that tensions in a country are caused by weaknesses or poor policy decisions within that country, there might be less willingness to take action at European level, using European resources. But we now have supervision of significant institutions at European level. This has, together with a greater focus on NPLs, made banks more robust. And this time, we have seen a common shock that is also affecting banks which are better off and supervised at European level. This strengthens the case for intervening with European tools in the event of tensions in the financial sector.
Should banks continue to not distribute dividends next year?
As long as it remains unclear how the situation will develop, banks should be prudent. If they do not pay out dividends this year, they can distribute more next year and are in the meantime better positioned to face a severe crisis situation. If I had the choice between the two approaches, I would rather be more prudent, but this might mean a cost to the banks. I believe that a reasonable solution, as economic conditions improve, would be a case-by-case approach by banking supervisors.
Are mergers and acquisitions within European banking an appropriate way of making the financial sector more robust?
Some mergers and acquisitions are successful and others are not. Empirical evidence suggests that those that are successful involve a stronger buyer acquiring a weaker “target”. I have not looked at every transaction in detail but my feeling is that most cases tie in with this pattern. They can also help reduce excess capacity in the European banking market, which in some cases results in inefficiencies, excessively low profitability and ultimately financial fragility. But we are still mainly seeing consolidation within domestic markets, rather than across countries. Consolidation across countries would be more beneficial for the banks themselves and for the European financial market as a whole, as it would allow for diversification of risk and reduce the impact of adverse developments in individual Member States.
On Joe Biden, US President-elect
We are facing global challenges that require a global response. It is essential that the world’s major economies and the international community work closely together, in particular through multilateral institutions. This would be an important step forward and would reduce uncertainty, including for trade and the global economy.
Compliments of the European Central Bank.