Governor Olli Rehn
Bank of Finland
Interview with Bloomberg, by Piotr Skolimowski and Kati Pohjanpalo
23 November 2020

How big is the risk that the EU recovery fund falls apart on the rule-of-law question and what does that mean for the ECB?


Monetary policy is done on the basis of central bank independence, and the ECB acts independently based on our price stability mandate. That’s a very clear principle and point of departure. Having said that, the Next Generation EU package is indeed necessary for Europe’s economic recovery. Overall, this Next Generation EU package has the potential to substantially support the regions and sectors that are the hardest hit by the pandemic. It can also strengthen the single market and help build a more lasting and prosperous recovery. I urge member states to take the full benefits of the package and its favorable conditions once agreed the funds should be deployed for productive public investment and accompanied by productivity enhancing economic reforms, that would benefit Europe as a whole and the member states. I’m confident that the member states will at the end of the day agree on the Next Generation EU and overcome the current hurdles that are being put in its way.

Are you preparing in any way for a scenario in which they wouldn’t?

As I said, I trust the member states will solve this issue, and I find it irresponsible that the financial framework and the Next Generation EU have been made political footballs. Monetary policy acts independently, and based on its price-stability mandate.

If you think about all the stimulus to the European economy, if the governments fail to supply this very key component, then will the stimulus that member states are providing and the ECB with its quantitative easing, is that all enough without this?

I trust the member states will finally, preferably sooner rather than later, settle this pending issue. It’s been one of the lessons of the previous crisis -- I’m referring to the financial crisis and euro-area sovereign debt crisis -- that monetary policy and fiscal policy need to work in tandem in a big crisis situation. That’s what’s happening now, both with the monetary policy of the European Central Bank and the fiscal policy of the member states are providing very substantial stimulus. Certainly this substantial fiscal support is needed this year and next year. Not forever, but still next year as well. This would be very much positively reinforced by an early adoption of the recovery fund and its effective implementation.

How would you characterize the economic outlook for the euro area as we head into December meeting?

`Currently the economic outlook is still characterized by pervasive uncertainty and the worsening of the pandemic situation. After a stronger than expected rebound in the third quarter, the current worsening of the pandemic situation in terms of the health situation has led to an economic slowdown in the euro area. The second wave of the pandemic is getting more severe than anticipated all over Europe. The worsening of economic situation and lockdowns mean that the downside risks to the ECB's September forecast have largely materialized. We can already see negative effects in some real-time data. The second wave seems to have particularly harmed the service sector and the recovery in the industrial sector is still surrounded by a lot of question marks. For instance in Finland we're really concerned that order books are rather empty or relative low for the coming winter.

The ECB's latest forecast foresees that pandemic situation would ease by the middle of next year. Certainly, fast and successful delivery of the vaccine or effective containment measures could reduce the downside risks, but we know that there's still a lot of uncertainty around that. That's why in the grand scheme of things fiscal and monetary policies are there to support households and companies and we'll need this still for quite some time.'

When you talk about the economy, does that mean you see a bigger risk of long-term scarring now that we enter the second wave even though the lockdowns as severe as in the first wave?

`The scarring effects of the second wave are likely to be significant and it’s necessary therefore to maintain ample monetary and fiscal stimulus to alleviate these possible long term effects, long-term ramifications of the crisis. It's a better to be safe than sorry and to avoid a premature tightening of financing conditions.

This is related to two discussions among the economics profession about zombie firms and hysteresis.

Our recent research paper on zombie firms in the pandemic concludes that this concern seems to be exaggerated. In fact financial support is by and large, or for the biggest part, going to companies that are viable in the medium to long term, as long as they can overcome the short term hurdles, and that’s why the hysteresis effect is in my view, a more important than the potential zombification on the basis of current information.

Hysteresis refers to the scarring effects, both for individuals as employees -- their competence tends weaken if they lose their jobs -- and the same goes for companies. We lose much of the productive and innovative capacity if companies go under. Therefore, at least now in the short term, rather than being overly worried about zombification and I would say it's rather the hysteresis effect that is dominating and we should avoid scarring effects in the economy.

There’s another aspect, which is that the pandemic shock has hit different sectors and jurisdictions in the euro area asymmetrically. In the long run, the crisis may lead to a divergence across countries and sectors. Potential output may have vanished in some areas to a large extent, low-skilled workers in many service sectors have been more exposed to the crisis. Until now policy measures have responded to the acute situation. In the medium term, however, it's important to promote effective investment and implement structural reforms to minimize the long term scarring effects.’’

The balancing act is that we need fiscal support but in the medium term we also have to be able to reallocate resources and that requires productive investment and structural reforms.’

Given your concern about scarring effect for the economy, do you expect a significant downgrade of your September forecast?

I wouldn't like to jump the gun or second guess. Let's wait another few weeks what the incoming data is going to tell us.

What would be your preferred choice of instruments when the ECB recalibrates policy in December?

In my view in December the question for us is not whether we take measures or not, but instead which measures we should take. All policy decisions always involve a cost-benefit analysis. For me the prime candidates are PEPP and TLTROs.

If you look at the PEPP, its stabilization function is provided by its flexibility, which is crucial given the unpredictable nature of the pandemic and the uneven impact across the economies. In this context, the flexibility of the PEPP allows us to respond in a targeted way to counter fragmentation risks. This was key in reversing the tightening of financing conditions we saw in the early days of the crisis and jointly with other central banks we were able to avoid turning pandemic into a financial crisis, which was a possibility in March.

Thanks to PEPP's flexibility, the ECB is also able to provide overall monetary stimulus beyond addressing the fragmentation risks. So it has two functions: the stabilization function and monetary policy stimulus function. Both are important. For PEPP, the flexibility means both size and duration.

Then if you look at TLTROs, the latest ECB bank-lending survey showed that some banks are expecting the tightening of credit standards. Therefore we may need to consider the recalibration of TLTROs.

The essential question is how we can ensure that the current financing condition remain at the current favorable level for as long as necessary in the view of the crisis.

How could you recalibrate your TLTRO program to better address the economic situation?

By and large, TLTRO-III has been a success story. We'll analyze its effects from all possible angles and dimensions, but since the work is ongoing, let's come back to this in December.

Is a rate cut definitely off the table in December?

Both PEPP and TLTROs have proven their effectiveness in the crisis context. That's why they are the prime candidates to be recalibrated in December. That may not be an exclusive list. As we have said, we keep all options open at this point. All policy decisions involve a cost-benefit analysis.

The Governing Council has been very clear about the choice of its instruments in December. Are you not concerned that the expectations for the package you're going to deliver might already be too high?

I'm always concerned about too-high expectations in making monetary policy. But we'll examine the incoming data, we'll carry out our economic analysis -- both top-down and bottom-up and we will have the new perspective for 2021 to 2023 that will provide us with a strong foundation to take decisions in December that are appropriate to the moment.

Along with that, we're obviously observing the developments in fiscal policy, both in the member states and in the European Union. That is a very important part of the coordinated policy response. Monetary and fiscal policy are now working hand in hand. It's important that fiscal policy continues to do its job and that's why the Next Generation EU is of paramount importance for Europe's economic recovery.

You said earlier you see a divergence in the euro area happening in the long run because of the asymmetric shock that this crisis has been. Do you think that should be taken somehow into account in the strategy review? Does that mean you have to change how you do monetary policy, if there's this long run effect?

We are already taking that into account through PEPP. Certainly PEPP will be, as it is one of the key instruments of the ECB, evaluated in the context of the strategy review. In fact, one of the forthcoming seminars is devoted to instruments, so I would expect that we will also in the context of the strategy review analyze PEPP, among other instruments, in the medium to long term. But as we make contemporary monetary policy on the daily or six-week basis we take decisions on the basis of incoming data and contemporary needs.

You held a number of listening events about the strategy review in Finland in the past couple of weeks. What was the most striking observation for you to come out of these events? What surprised you?

I would rather respond to what was the most essential observation and that's related to our core business, which is price stability. For me, the striking thing, the essential thing was that there was a broad support for such a definition of our price stability target that supports sustainable growth and job creation, even to the extent that full employment should have a stronger place among the objectives of monetary policy. That is certainly an important observation that there was support for, if not a dual mandate per se, but emphasizing full employment more in the current low inflation context.

Second,  climate change and policies to contain it, to mitigate it, was quite central in these discussions. And of course, there is more divergence of views as regards specifics, but there is a broad recognition by our national stakeholders that climate concerns and principles of responsible investment should be taken into account in the strategy review.

What is your view on the suggestion of having a much much longer timeline as you look at policy, up to 100 years, if I remember someone suggesting with regard to climate considerations?

It makes plenty of sense as a general mindset, as a general orientation of reflection and thinking. However, it’s somewhat more difficult to operationalize it concretely in the monetary policy framework.

I recall, when I was Minister of Economic Affairs some years ago and I was responsible for leading the work for the preparation of the current national energy and climate strategy. What we did was we had the timeline for 2030 and we had quite specific objectives in terms of reducing our carbon gases and quite ambitious objectives, which have been adopted by the government and then by the parliament a following very open, Nordic style hearing process. What we did was we had a workshop together with Greenpeace and the Aalto University about energy trends until 2050 and we drew some conclusions, which were published as part of the broader report, but they were not as such adopted by the Parliament.  I see some equivalents here, it's very useful to look at longer term trends or even the whole century -- and a century is not that long if you think of climate change, frankly -- but at the same time you have to have an operational timeframe you’re your decisions. For energy policy, it’s likely to be 2035, so it's about 10 to 15 year timeframe, which makes plenty of sense to me.

You’ve been calling to make this an exercise that happens regularly as opposed to just doing strategy reviews as a one off here and there. Are you getting support for that?

We are now in the middle of the debate in the Governing Council, so it's not the time to draw definitive conclusions. There have been discussions on this and we will see once we wrap up, various elements of the strategy review what is our collegial conclusion. My personal view is that, yes definitely it would be useful to have regular or periodic reviews, for instance, every five years. That's also because we live in a world of continuous change and you have to take these structural changes and the evolution of our economic environment into account, when making monetary policy and deciding on our monetary policy framework.

You alluded to it earlier about how the aspect of employment or more broadly social issues should also be something that the ECB could look at as part of its type of its mandate. The treaty gives you that opportunity, but in practice, how could you actually do it as part of your review so that your target reflects also the social aspect? Have you gotten any kind of feedback from your colleagues on and looking at your target and mandate more broadly as you do this strategy review?

It’s important to recall the essential rationale of the review, which was very elegantly coined by Christine Lagarde recently when she said that `we need to thoroughly analyze the forces that are driving inflation dynamics today and to consider whether and how we should adjust our policy strategy response’. That’s the essential objective of the strategy view and the work is moving forward in a very positive spirit.

Last week, we had the opportunity to exchange views about the past performance of the ECB. We discussed various aspects of the definition of the price stability objective and we also had an exchange on the possible makeup approaches to help address the constraints imposed by the lower bound. The review is ongoing and we are currently in the middle of the debate, thus it is not yet the time to draw definitive conclusions and I maintain an open mind and want to look into further analysis on the way and I think this is the approach of my colleagues as well.

Having said that, let me nevertheless share some of my personal views on some of the key issues on the review. One of the key issues is that in the early years of its operation the ECB, while seeking to set up credibility when too high inflation was the main concern, and it assessed the zero lower bond problem as of relatively little concern at the time. In the current environment and in the world of low rates and mostly negative economic shocks, demand shocks, the problem of too high inflation is more remote and the problem of low inflation is clearly more relevant. So therefore the question now is rather: how do we ensure that inflation expectations will be not forever stay anchored at too low levels. That's very much the essential challenge that’s of course related to the discussion on the lower level of a neutral rate of interest. In terms of analysis, that’s the analytical core of the strategy review.

Concerning then, say, how we could look for solutions to these. There are two ways of reducing the risk of too low inflation and inflation expectations. The first one is by having a clear and genuinely symmetric definition of price stability -- and these are complimentary, not alternatives -- and the second is having a reaction function that underlines the commitment to symmetry and also takes into account the increased probability of monetary policy hitting the lower bound of interest rates.


In my view, a symmetric point target, is simple and easily comprehended. It would serve best our needs, since it anchors inflation expectations rather effectively and will enable clear communication on our monetary policy decision making. The current definition of price stability and inflation is perceived as asymmetric and it reduces the effect of communication and forward guidance. At the same time, the medium term orientation of monetary policy will provide us the necessary flexibility and therefore, in my view, no range is needed for that purpose either.

One more aspect is that in order to optimize our instruments and our tool box, we need to carefully analyze different makeup strategies also in the light of what the Federal Reserve has decided. We’re not working in a vacuum.

As for the mandate, that's related to your question on social aspects and employment, let’s recall that the ECB is mandated, without prejudice to price stability, to support to the general economy policies of the European Union. As long as we are not compromising price stability, we need to work for balanced economy growth, full employment and sustainable development.

Thus our mandate is not just dual, but rather a triple or quadruple one, including maximum employment just like in the case of Fed. In the current environment, as a problem is inflation anchoring at too low levels, the policy prescription clearly very singular for both achieving price stability and the supporting sustainable growth and the job creation.

Have your views, or your expectations, of Brexit, changed in any way? And are you making any preparations for Dec. 31?


It’s a big mess, and it’s mostly outside our remit. It’s a big, regrettable mess. We have our contingency plans ready, we have updated them over the years, and now it’s up to the British government mostly to see how they organize their relations with the European Union.

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