Governor Olli Rehn
Bank of Finland
Interview in Handelsblatt, by Jan Mallien and Frank Wiebe (the English version)
Published on 1 July 2020
An edited transcript of the interview

Mr. Rehn, last week Austria issued a 100-year bond for less than one percent annual return. More and more economists are worried that capital markets are too dependent on the central banks and no longer reflect reality. What do you think?

The global economy is navigating extraordinary times. One of the unusual phenomena in this crisis is the decoupling of the markets, especially the stock market, from the real economy. But you also have to ask yourself what's behind it. The central banks tend to follow a trend towards ever lower interest rates, they do not determine this trend.

But the European Central Bank (ECB) fixes the deposit rate and dampens yields through bond purchases.

For the ECB, the neutral equilibrium interest rate is an important indicator ...

... the interest rate that enables full employment without higher inflation.

Yes, and most economists agree that this real equilibrium rate has continued to decrease. The reasons are the aging of the population, which leads to a higher savings rate, globalization and, in Europe, the free movement of workers, which is dampening the rise in wages and prices. In addition to that there are the - possibly even permanent - effects of the corona pandemic.

Central banks have already invented new instruments in the financial crisis ten years ago in order to loosen monetary policy further despite the already very low key interest rates. Will the ECB soon practice yield-curve control and target a range within which the long-term yields of euro-area countries can fluctuate?

Other central banks, especially the Bank of Japan, have already done so. The ECB has used its monetary policy toolbox first and foremost to stabilize markets. The ECB can use its new pandemic emergency purchase program to buy bonds in a relatively flexible manner, so as to ensure the transmission of monetary policy. Nevertheless, in the PEPP the capital key remains the anchor and the purchases need ultimately to converge to it. We have managed to improve the transmission across jurisdictions. The government bond spreads have narrowed down. But I don't think there is a scientific method to determine the appropriate level of the spreads.

An innovative instrument are medium-term, discounted loans to banks, the so-called TLTROs. Most recently, banks took-up a record volume of 1.3 trillion euros of them from the ECB. Is there a risk that non-performing loans will accumulate in the banks balance sheets?

These TLTROs have been designed to strengthen lending especially to medium and small businesses. After the financial crisis, banks reduced their balance sheets for years by cutting back on lending. That was a burden for the economy. We had to stop this kind of downward spiral. The high demand in recent TLTROs is a positive sign hopefully reflecting an easing of lending conditions in the euro area. But of course we should also be careful that the lending is not channelled to finance too many zombie companies, companies that are actually not viable.

In the meantime, there was talk of the ECB setting up a so-called bad bank, a collection point for bad credit risks. What is your view on that?

I can still well remember the banking crisis in Finland in the early 1990s, where we successfully used such a bad bank. But it may not make sense to install that at European level. You need a very good knowledge of the national and regional real estate markets in particular.

So would national solutions make more sense if there was a need?

We had a successful bad bank in Spain after the financial crisis. It was endowed with 100 billion euros, of which only 43 billion were needed. This enabled a very professional restructuring of the banks there.

How big is the economic damage caused by the pandemic in your opinion?

The ECB has three scenarios, one with minus six percent in growth this year, one with minus nine percent and the worst with minus 13 percent. I think the middle variant is likely, but I can not rule out the worst either.

In many countries, the economy is slowly reopening again.

Yes, but export-dependent nations like Germany in particular rely on the global economic recovery. This also applies to Finland, where we now have 100.000 less people at work than before the Covid-19 crisis, this number is similar to the level during the financial crisis.

Is there any prospect of improvement?

After the pandemic started in China and spread to Europe and then to the US, we are now experiencing the fourth phase when the epidemic has hit the emerging markets. So far, 70 countries have received help from the International Monetary Fund (IMF). Case numbers are still increasing in three major countries, the United States, India and Brazil.

When do you think the European economy will return to the pre-crisis level?

If there is no serious second wave of the pandemic with appropriate countermeasures, this could be the case in around two years.

And how long will it take before countries in the euro area have reduced the mountains of debt they are accumulating to combat the crisis?

Much longer. In the financial crisis, debt grew from 60 to 90 percent of gross domestic product (GDP). This wiped out around two decades of debt reduction. Now we also have to expect a 15 to 20 percentage point increase in debt.

Isn't that too dangerous?

Germany has reacted very strongly in terms of fiscal policy, and that is very welcome. Unfortunately, not all euro-area countries have a similarly wide scope. But overall, the economic crisis we are facing is severe and requires forceful monetary and fiscal stimulus. The ECB has taken rapid and proportionate action resulting in an increase in its balance sheet. The stimulus measures ease overall lending conditions and also compensate for the fact that private households save more.

Doesn't that drive inflation up in the long run?

In the short and apparently also in the medium term, the effect of the Covid-19 pandemic is disinflationary rather than inflationary. Moreover, the danger of deflation has re-emerged. We have a supply and a demand crisis, but above all the demand is missing. Initially, this tends to depress prices. But we have to watch the risks closely, there is no magic cure that works forever. If inflation should pick up again at some point, the ECB will react, and nobody should fool itself. Price stability is our mandate.

However, some countries cannot afford higher interest rates.

That is why my core message is: Governments must use the time of low interest rates for reforms that boost growth and generate jobs. That will also enable reducing the high levels of public debt.

You mentioned the ECB's mandate. It is true that its primary mandate is price stability. But there is also a secondary mandate to support the general economic policy of the European Union (EU). This includes full employment, for example. Why is the ECB not talking more about this secondary mandate?  This would be more understandable for the general public than the discussion about decimal places in price developments?

First of all, price stability is firmly set in the EU Treaty. Still, I wouldn't call full employment secondary. Like the fight against climate change, this is an important goal that we support unless price stability is compromised.

ECB President Christine Lagarde has promised better communication. What has followed from that?

The ECB under President Lagarde is very much focused on providing understandable communication to citizens. This is part of our big strategy review debate, which we had to postpone to September because of Corona. But of course we are already preparing it in the background.

How should the environmental issue be considered?

In the Finnish central bank, we have already decided to avoid investing in environmentally harmful areas, for example, climate-damaging industries, in accordance with the United Nations Principles for Responsible Investment. I will advocate that this also happens at the European level.