Mr Villeroy de Galhau, almost everywhere in Europe and the euro area the number of Covid-19 infections is increasing rapidly and in many places policymakers are reacting with new restrictions. How worried are you that this fourth wave of corona will further exacerbate the recent weakening of the euro area economy? Is there even a threat of another recession?

No! There is a strong economic recovery in the euro area this year. Growth should be around 5%. The euro area economy is just returning to its pre-crisis level . That is six months later than in the US, but six months earlier than expected a year ago. Of course, Europe has to remain extremely vigilant on Covid. But in all economies we have learned to live, produce and grow economically with covid – and to protect ourselves.

So the pandemic has lost its terror, at least economically?

Health remains priority No.1. But the experience of the past 20 months shows that each new wave of coronavirus  has caused less economic damage than the previous one. One thing must not be forgotten, either: Vaccination is more advanced in Europe than on any other continent. This is a great sanitary achievement but also an economic advantage.

While the economy is slowing down, inflation in the euro area is rising strongly – and even more strongly than expected and now for longer than expected. In October, the inflation rate was 4.1% – as high as only once before since 1999. Is this really just a temporary phenomenon, as the ECB argues?

Inflation in Europe remains significantly lower than in the US, still more if you look at “core” inflation excluding energy and food: 2,0%, versus 4,6%. But true, it is higher than expected. What is crucial is to look at the reasons. European inflation is not demand-driven; there is no excessive demand for goods compared to pre Covid level. Inflation in the euro area is clearly driven by the supply side; it is the result of bottlenecks due to the re-start of the economy after the pandemic. This is evident in energy, in raw materials, in key industrial components such as microchips. We take these tensions very seriously; but they should ease over time.

So all not so bad and not permanent?

It is an inflation hump. It would be misplaced to forecast exactly how high it will be by decimal figures, and how many months it will last. But there is no doubt that most of this hump is temporary. Hence, the concern about “stagflation” is misleading. Firstly, we are economically far from stagnation. And secondly, as I said, inflation is mainly due to supply bottlenecks. We should rather speak of “shortflation”, referring to these transitory shortages. For us as the ECB, this means that we must be at once patient and vigilant.

And that means exactly?

Patience because a premature tightening would be a mistake. That would add a negative demand shock to the temporary supply problem. But we also have to be vigilant on both sides. We have a clear commitment to achieve our inflation target of 2% in the medium term. If inflationary forces were to become more persistent, we would not hesitate to act. Have no doubt about our willingness and our capacity to anchor inflation at 2%. We need to monitor wage developments very closely. They could turn a temporary phenomenon into a longer-lasting problem. So far, however, we do not see signs of general strong wage increases across sectors and countries.

Your colleague in the Governing Council, ECB Vice-President Luis de Guindos, has warned that the perception of inflation could change, with longer-term consequences.

So far, market long-term inflation expectations remain well anchored around 2%. But in these uncertain times, we must be more than ever data- driven. This is what I call “committed pragmatism”: definitely committed to keep medium term inflation around 2% ; absolutely guided by actual economic realities and their possible changes.

ECB President Christine Lagarde has announced that the Corona emergency bond purchase programme PEPP will end in March 2022. Will it stay that way despite the new Corona wave? And if so, will other measures be needed to avoid negative cliff effects – such as an increase in the parallel APP bond purchase programme?

I don’t think current developments change this assessment. From today’s perspective, we should end PEPP net purchases in March 2022. We will do what we said, and as it is already expected by the financial markets, one should not fear too much “cliff effects”. What we will do beyond that is still open for discussion and decision from December. But when it comes to the general direction of our monetary policy, I think there is a broad consensus in our Governing Council. For me, there are two steps. First, we have to exit from our covid crisis instruments – just as other major Central Banks  are doing. That applies to PEPP and to the present TLTRO program. Afterwards, as a second step, we will begin to gradually adapt  our monetary policy accommodation, deciding about APP net asset purchases, then key interest rates and asset reinvestments. The direction and the sequencing are clear. What is open and must remain widely open are the timing and the pace along this path, scrupulously monitoring the economic and inflation outlook.  And we can draw lessons from the success of our crisis instruments.

What do you mean exactly?

We should learn two lessons in particular. The first relates to PEPP : Flexibility is at least as important as volumes. This is why increasing the net purchases of APP after PEPP is at this stage a possibility, but not yet a necessity. PEPP has been so successful because it offers flexibility in three ways. The first component relates to timing. There is no fixed amount per month. Such flexibility could easily be transferred to the APP. The other two components are about flexibility in terms of asset classes and jurisdictions. For example, at the beginning of the Covid crisis, there was a lot of tension in the commercial paper market. Thanks to the flexibility of PEPP, we were able to intervene strongly for a short time and the problems quickly disappeared. This is a good example of what I call a contingency option. Such flexibility is not relevant for the APP. The APP has its own legal status and rationale. But it is worth looking at how we can preserve such elements of flexibility in other forms in the future, as part of our “virtual toolbox”.

PEPP is also more flexible because it allows for greater deviations from the ECB capital key and there are no purchase limits as with the APP. Should this also be maintained?

PEPP also has its own limits and rules. And it’s not about helping country A or country B. It is about efficient monetary policy transmission throughout the whole euro area and for all economic agents. Interestingly, we have not had to use this flexibility that much.  The very existence of this flexibility has helped to ensure the efficient transmission of monetary policy.

You spoke of two lessons. What do you have in mind besides PEPP and its flexibility?

The second lesson relates to our long-term refinancing operations for banks, the TLTROs. There are two elements here: One is the price of the loans. There is a kind of subsidy for the banks under certain conditions. That made sense in the exceptional circumstances in 2020, but no more today. We should therefore stop it. The other element is the volume of funding: TLTROs have been effective liquidity tools to preserve the volume of credits to SMEs and corporates. Here, we should be mindful of possible cliff effects in the future, and not rule out the  option to provide a liquidity backstop.

Your colleague, the Dutch central bank chief Klaas Knot, warns against the ECB committing too much to a foreseeably loose monetary policy – especially in times of high inflation and increasing inflation risks.

I never comment on statements made by my colleagues. That said, as we continue to be in an uncertain situation, we have to maintain some optionality. We should be very predictable on our target – the 2% inflation- and direction, as I said, while not being too precommitted on our instruments and calendar. There is no need to tie our hands unduly.

The head of the Austrian central bank, Robert Holzmann, has said that the ECB could end all bond purchases, including the APP, in September 2022. Is that a realistic option?

These reflections are premature. As I said, we are absolutely data-driven. This is not just a question of caution. It is a question of professionalism and credibility towards our mandate of price stability.

When you emphasise data dependence and uncertainty – is it really possible to rule out interest rate hikes in 2022, which the markets are already speculating on?

We formulated clearly three conditions for a rate hike in our Forward Guidance in July. If you look at the outlook for inflation, as Christine Lagarde rightly stressed,  it is today very unlikely that these conditions will be met next year.

The ECB’s top banking supervisor Andrea Enria recently said that by now the disadvantages of low and negative interest rates outweigh the advantages for banks. The Governing Council has always argued that the balance is positive.

First of all, we make our monetary policy for all citizens and economic agents and not only for financial institutions. By the way, banks benefit today from the very favourable pricing of TLTRO, as mentioned earlier. But it is clear that the solidity and health of European banks is important for the efficient transmission of our monetary policy and for financial stability. That is why I was one of the first to plead for tiering…

… that is, for a two-tier system exempting partly  banks’ excess reserves from the negative ECB deposit rate.

If you look at the situation today, the excess liquidity of banks is much bigger than two years ago, when tiering was introduced in 2019. Hence, there are strong arguments for increasing the tiering multiplier.

Will this also be discussed and decided already in December?

We are a month away from the meeting, so let us keep patient ! We will in December make the decisions that are then necessary  – consistently with our new ECB forecasts and economic analysis. But December will not be the last monetary meeting. Some decisions could be taken later, and a certain optionality should likely be maintained.

Many critics argue that the ECB will not be able to raise key interest rates if that should become necessary because then some euro states would immediately get into trouble – in other words, a regime of fiscal dominance…

No! I have to interject and contradict you right away. Yes, European governments have very high public debt levels, and that is partly justified by the Covid crisis. But as a central bank we can never and will never guarantee low-interest rates for ever. What we must guarantee is 2% inflation for the citizens and economic actors Fiscal dominance would be absolutely incompatible with our price stability mandate, and our independence.

But some observers even see the ECB already trapped in fiscal dominance.

No, we are not. We are serious about the end of PEPP. We are considering the gradual adaptation of monetary policy support, which will not follow a political calendar; we will not be driven by politics.  The course will be purely determined by the economic outlook. Everyone around the Governing Council table is legally committed to the price stability objective. This is not just a German commitment.

In Germany, criticism of the ECB has recently become more strident again. How dangerous is that for the ECB and the euro?

I have a very personal relationship with Germany. That’s why I’m aware of Germany’s concerns and take them very seriously. And I promise: the ECB Governing Council will not bow to any political pressure. Irrespective of this, let me add that some recent criticism directed to the person of the ECB President has been clearly unwarranted.

The announced premature resignation of Bundesbank President Jens Weidmann at the end of the year has intensified this – especially in times of high inflation.

Inflation in Germany is today higher than the euro average. That is part of the widespread concern. But the Bundesbank and the Federal Ministry of Economics also assume that this is a temporary phenomenon. Once again, there are currently two possible policy mistakes and we must avoid both. We must not overreact and tighten monetary policy prematurely. But if the situation changed, we should  not hesitate to act. Regarding the resignation of Jens Weidmann, I have to say – I am losing a friend in the Governing Council. We had a close and confident relationship. Of course we sometimes had discussions. If it weren’t for that, the Governing Council would be useless. But the discussions were always very objective and loyal.

Weidmann is not the first German central banker to leave the Governing Council or the ECB Executive Board prematurely. Isn’t that a problem, when German central bankers apparently can hardly stand ECB monetary policy in the long run?

First of all, this is a personal decision and one has to respect it. But the fact is that Jens Weidmann has now been the longest serving member of the ECB Governing Council, for more than ten years. He has been a very active central banker during that time. This is an impressive achievement. So I don’t think there is any “malediction” on the German central bankers in the ECB.

But are the German ideas of a central bank and of monetary policy perhaps incompatible in the long run with those in most of the southern euro area countries?

I disagree. We have unanimously committed to the Euro Treaty 30 years ago, based on the price stability mandate and the  independence of the central bank. Personally, I strongly believe in these two German values. We adopted the new ECB strategy  last July, also unanimously – with the clear and symmetrical 2 percent inflation  target. The success of the ECB is firmly  based on the success of the Bundesbank. Therefore, it would not be serious now to pretend that there are irreconcilable differences in philosophies. 80 % of European citizens, and 84 % of Germans, support the Euro: this is our collective success.

The interview was conducted by Mark Schörs.