"There is still a lot of restrictive impulse in the pipeline"
Mr. Stournaras, let's start right away with the million-dollar question: After the European Central Bank's (ECB) tenth consecutive interest rate hike, have we reached the interest rate peak?
Yes, I think we have reached the interest rate peak. That is my feeling and my understanding.
What makes you, or rather the Governing Council of the ECB, confident that the interest rate level now reached of 4.5% for the key interest rate and 4.0% for the deposit rate is the right one? Why not 25 basis points less or 25 basis points more?
Monetary policy is not an exact science. But our impression is that the interest rate level we have reached now, if we maintain it for some time, will lead to inflation being back at our target level of 2.0% by the end of 2025. Maybe it will even be a little earlier.
However, the real interest rate, i.e. the key interest rate minus inflation, is still negative even after the latest interest rate hike – given an inflation rate of 5.3%. Critics argue that this is not restrictive enough.
First of all, real interest rates should not be calculated with current inflation, but with expected inflation. Otherwise you are making a big mistake. Basically, however, we should not be too fixated on real interest rates and not only look at the level. It is also about the change. The key interest rates have now increased more strongly and quickly than ever before, and as a result, the financing conditions for households and businesses have also tightened considerably. This is also very evident. Take, for example, the new growth projections of the ECB economists. They predict de facto stagnation for 2023. Not low growth, but stagnation. The projected 0.7% growth results almost entirely from positive overhang effects from 2022. The demand for bank loans has also declined significantly. Monetary policy is already biting significantly and dampening demand considerably.
However, inflation is still clearly too high at 5.3% and, above all, the underlying price pressures are very persistent.
Our primary mandate is price stability and we want to bring inflation back to 2.0% in a timely manner – that is very clear. But we also look at the economy, we also care about growth and employment. We also feel a social responsibility. Moreover, lower growth leads to less inflation in the medium-term. You should also not forget: Monetary policy works with a time lag. So, given the significant monetary tightening since July 2022, there is still a lot of restrictive impulse in the pipeline.
Critics of the rate hike even say that the ECB is increasing the probability of a recession in the euro area with the new rate hike.
That is true. I would also have preferred to leave the key interest rates unchanged. The clear decline in inflation, the stagnating economy, the tightening so far – in my view, that would have justified not raising rates. But there were good arguments on both sides and that's why I can live with the decision. However, one should not overdo it with the restrictive monetary policy. Otherwise there are also risks for financial stability. I am very worried about the "snowball effects"...
... in other words, a situation in which interest costs exceed nominal economic growth and the debt ratio rises.
Yes, exactly. Many people think that this is only relevant for states and public finances. But it also applies to private households and companies. We can quickly get into big problems there. So far we have been lucky that nominal growth has been much higher than interest costs. But that can now turn around. It is therefore all the more important that everyone else makes their contribution. That is why we are appealing in particular to fiscal policy and made this very clear at the most recent meeting of the informal Ecofin in Spain.
What does that mean in concrete terms?
First, we now need at least a neutral, but rather a more restrictive fiscal policy so that we can stop raising interest rates. If there were broad spending programmes now, we as the ECB would only have to tighten even more to dampen demand. That would not help anyone. Secondly, should the economy need support, the aid must be very precisely targeted at the weakest in society and focused on future investments that increase productivity – for example, in digitalisation and the green transformation. Thirdly, we need a quick agreement on the new EU fiscal rules. We need more flexibility and stronger anti-cyclical rules that nevertheless provide incentives for debt reduction. The European Commission's proposals are a step in the right direction. If we were to return to the old Stability and Growth Pact, we would be dead and buried. Monetary and fiscal policy must now be strategic complements.
And you are not worried about the independence of the ECB?
Being independent does not mean not talking to each other. We have to cooperate. By the way, we should also complete the monetary union.
What do you mean exactly?
We need the banking union and the single deposit guarantee scheme. Europe needs a more level playing field. In many respects, Germany is still more equal than others. Only then will there be the necessary cross-border mergers of banks and companies. We should also think about more joint spending. It is perhaps too early for a common, powerful EU budget. But we should look at where it makes sense to spend money together – defence, climate protection and others. We have to stop thinking in national categories first. We have to act more together in Europe. If we were to agree on the new fiscal rules and on the banking union, that would give an enormous boost to the European economy.
Let's get back to monetary policy. After the latest interest rate hike, the financial markets are betting heavily on interest rate cuts in 2024, possibly as early as spring. Are you happy with that?
It is still too early to say when the key interest rates can be lowered again. We first have to keep them at the current level for some time. We have also communicated that.
"Sufficiently long", is the phraseology. What does that mean?
It is difficult to say. In any case, we are talking about a few months. We will have to decide how many, depending on the data.
But you would say in any case that regardless of the specific date, the ECB's next interest rate step will be an interest rate cut, not a hike?
The uncertainty is great and there are risks. But as things stand, I assume that our next step will be an interest rate cut.
Another discussion is about the ECB's balance sheet, which has been inflated by the bond purchases. Some of your colleagues on the Council are calling for more speed in reducing the balance sheet and in particular for reinvestment in the Corona emergency bond purchase programme PEPP to be scaled back sooner than at the end of 2024. What do you think of this?
We have to be very careful about that. For now, we have tightened monetary policy enough. We are already reducing the balance sheet very strongly because we have ended the reinvestments in the APP. If we were to increase the pace significantly now, there could be an outcry in the markets and turbulences. We should not take any unnecessary risks. This is all the more true because PEPP gives us the necessary flexibility to act if there are problems with the transmission of monetary policy.
And that then also applies to active bond sales – instead of just ending reinvestment, as with the APP.
Such a move would be very risky. By the way, there is a second argument. If we were to sell bonds, we as central banks would realise losses on those bonds that are so far purely theoretical and will not become reality if we hold the securities to maturity. Why would we do that?
And what do you think about an increase in the minimum reserve ratio, which currently stands at 1%. Some central bankers are sympathetic to such a step, which would reduce the enormous excess liquidity in the system somewhat.
Here, too, we should first give our existing measures time to unfold their full effect. We should not rush into new decisions now. The tightening so far – the interest rate hikes, the balance sheet reduction, the reduction of liquidity support – is enormous. Our monetary policy is one the most important reason for the significant weakening of the economy that we are seeing. That was and is intended, because we want to dampen demand. But we must not overdo it either.
So from your point of view, the greater risk at the moment is to tighten monetary policy too much rather than too little? Some of your colleagues argue the other way round because of high inflation.
Yes, for me the greater risk at the moment is to do too much. We shouldn't and don't need to completely kill the economy. Inflation will fall significantly in the coming months. By the end of the year it should be around 3%. Core inflation has also turned the corner. The core rate is following the headline rate with some delay. This is all going in the right direction. We should also learn lessons from the past. We don't have to tighten until something has completely broken in the banking system or the economy.
In your view, is the ECB partly too fixated on the current inflation figures instead of the outlook – possibly also because of the underestimation of inflation in 2021 and 2022?
Yes, that is definitely the case. I don't doubt the motives. Especially in Germany, it is in the DNA to be very alarmist about inflation. But we have to make monetary policy forward-looking, not backward-looking.
And it doesn't worry you that recently some indicators of inflation expectations have picked up again somewhat?
The increase is relatively small and, all in all, inflation expectations are still very well anchored. And the increase is more than compensated for by the decline in growth expectations. That, at least, is not a cause for too much concern.
And what about warnings of a second wave of inflation like in the 1970s? Well-known economists also see such risks and therefore warn the central banks not to give in too soon again.
The situations are not comparable and there are many reasons for this. Back then, many countries had inflation-indexed wages, including Greece. Today, this is only the case in very few countries. At the same time, trade unions are much weaker than before. And there have been important reforms in the labour markets, they are much more flexible today. We are no longer in the 1970s.
But don't wages in particular pose a major inflation risk? They have risen significantly recently.
It is normal that there is a catch-up after the significant real wage losses. But so far all is within reason. Incidentally, wages in the euro area are rising about the same as in the USA, where inflation has already fallen much more sharply. In the Euro area, however, unit labour costs have risen much more strongly. And why? Because productivity is so low here and has even fallen recently. There are many reasons for this. One reason is that companies hold on to their employees even in times of crisis, because in times of a shortage of skilled workers they are otherwise worried that they will not be able to recruit anyone later. A second important reason is that we are a net energy importer. This currently has a negative impact on productivity through negative terms-of-trade effects. However, we cannot do anything about this in terms of monetary policy. On the contrary, if we raise interest rates, investment declines and productivity declines even further. Our dilemma is therefore even bigger than in the US.
The interview was conducted by Mark Schrörs.
