Governor Erkki Liikanen: Interview with Börsen-Zeitung, 6 October 2015

 

Mister Liikanen, the Euro area economy is growing, even above its potential rate, the credit cycle has turned into positive territory, unemployment is declining – is there right now really a need for the European Central Bank (ECB) to think about loosening further the already unprecedentedly loose monetary policy?

If I may I would like to start the discussion from another angle – from inflation.

Please.

 

We have an inflation target of below but close to 2%, in the medium term. At the moment the inflation rate is very low and well below this target, and even our forecast for 2017 is a little below the target. If we take our mandate seriously we cannot ignore that and we have to be vigilant. This is even more the case because risks for growth and inflation are tilted to the downside. But you’re right, there are also some positive developments. The PMIs are positive, especially for the countries in the Euro area periphery. Lending is also improving, even if this is not fully reflected in the real economy so far.

So, what does that mean for the question of additional monetary stimulus?

First of all this means that we have decided on an asset purchase program in January this year and that we have said, that this will go on until September 2016 – or beyond, if necessary. We have to stick to that and implement it fully. We also should not forget: Monetary policy always works with a lag. If I compare the situation with a marathon I would say that we are only at kilometer 15. Let’s keep the tempo and let’s stick to our plan. And if things change, we should not draw any hasty conclusions.

So it is premature that market participants increasingly see an expansion of the asset purchase program (Quantitative easing, QE) as a done deal?

We have said that we are going to buy until September 2016. And we have committed ourselves to buy longer if it becomes necessary. Our program is flexible enough to be adjusted – regarding the size, the composition and the duration. This holds true. We do not need to say more at the moment.

But isn’t there again a risk that also due to the ECB’s communication expectations mount enormously and that the ECB finally has to deliver in order to avoid a negative market reaction?

It is very important for us to follow what markets think. And we communicate in a way that market participants understand what we do and why. But we decide on our policies ourselves and completely alone. Markets’ mood changes daily – our policy aims at the medium term.

So you are not afraid of becoming a prisoner of the markets?

No. Our mandate and our analysis drive us – not the markets. And this is how it should be: We could not let markets dictate our policy.

Economy is also a lot about psychology. Don’t you think that it would strengthen the confidence in the Euro area economy if the ECB starts talking more about the positive developments and not always only about the risks?

This is a very good point. We have to tell the good news, but we also have to talk about the problems. We have to get the balance right.

If you talk about risks you refer to China and the oil price, right?

The situation in China and the Emerging Markets and the low oil price are the biggest downside risks at the moment. But it is too early to tell whether these developments are temporary or have lasting implications. For example the low oil price seems to be supply-side driven – that would be less problematic compared to demand driven factors. I’m sure when we meet in Malta…

… at the next monetary-policy meeting on October, 22th…

… we will already know much more.

The renewed fall in oil prices have pushed the inflation rate again below zero in September, to –0,1%. But in the past the ECB has always argued that it has to “look through” such extreme fluctuations in the oil price.

Yes, we have always said that we need to look through the changes in relative prices. What is important for us are the second-round effects. We have argued this way when oil prices went up and that must also be the case when oil prices go down.

And do you see such effects?

It is still a little bit too early to say. But what we observe are some new developments: For example how quickly changes in the short-term inflation impacts the longer-term inflation expectations and how much impact the oil prices have on these expectations at the moment. We should not be too hasty with conclusions, but we have to analyze it. We need more time to do that work.

The longer-term inflation expectations should not be influenced by recent oil price developments. Do you think that especially the market-based inflation expectations are still a reliable indicator?

Whenever inflation expectations go down more than we like to see we have to be careful and monitor it – whatever the reasons are. The question is how we react. But one thing is clear: We have to be loyal to our mandate. This holds true if inflation is too high and also if inflation is too low.

Do you see a risk of deflation in the Euro area at the moment?

Deflation is definitely less of a risk at the moment than it was at the end of last year. But we need to be careful and consistent in our assessments.

Some observers see the renewed drop in inflation as an indication that QE is not working.

Our program is a long-term project and we do not question it every single day – because it is working: It had an impact on inflation expectations and it is supporting the economy.

Would an expansion of QE really have a big impact? The experience of the US central bank Fed seems to signal that there is a diminishing return with every new QE program?

Some people even say the most efficient measure is the announcement itself. But seriously: We implement now what we have decided. We should not be impatient now. If you speculate too early about doing more it also weakens what you have already decided on. I hope it will be enough to buy until September 2016. If not we have said what we have said. But again: We should not be impatient.

If the Governing Council comes to the conclusion that more QE is needed – would it be more efficient to expand the program or to increase the monthly-run rate of 60 bill. Euro?

When we decided on the program the most important thing to me was the Forward Guidance. To me the commitment for the accommodative monetary policy  is the key.

Some experts argue that under the current rules the ECB would not be able to expand the program significantly because the ECB would soon run out of bonds for countries like Germany.

We had this kind of discussion even more when we started the asset purchase program. Back then it was said we would run out of bonds within weeks. This has not happened. I am not worried about our capability to deliver what we promise.

Can you imagine that the ECB stops buying according to the capital key, because at the moment it buys large amounts of German bunds – or would such a decision call into question that QE is monetary policy instrument?

I would not change anything now. We have planned this program very carefully.

We have said that and I have nothing to add to that.

The more the ECB loosens its policy the more difficult the exit is going to be. Should this play a bigger role in the considerations?

When you have the risk of deflation you are in a new territory. We have had to innovate new instruments. But you can be assured:  It is deeply in our mindset that we want to bring this policy to an end. If you look at the US experience you see how difficult the exit can be. But for us this is a luxury problem for the distant future. When our economy starts to improve on a broad base I will be happy to deal with the problem of the exit. When we get there we will be ready and able to exit.

You are a member of the Governing Council since 2004. Al lot of critics say that the ECB has moved away from its approach of following a more cautious “steady-hand policy” and that it has started, like the Anglo-Saxon central banks, to intervene more pro-actively and aggressively in the markets. How do you see the development of the ECB?

Yes, the ECB has changed. But the world has changed even more. These crises should not have happened because everybody thought that markets would always correct themselves. This belief has proven to be overly optimistic. This also means that from time to time central banks have to play a bigger role. You also have to admit that the so-called Anglo-Saxons are not always wrong. We should have enough self-confidence to follow what has proven its value for other central banks.
But one thing has absolutely not changed: our commitment to our mandate, to price stability. We are deeply rooted in the European tradition of monetary policy which is very much linked to the Bundesbank. The Bundesbank was the best central bank in the world for decades.

But a lot of people see especially this connection as being cut off completely.

I don’t agree. Price stability and independence have been very important for the Bundesbank and they are also important values for the ECB.

In the Euro crisis the ECB has also become a political actor – for example as a member of the Troika. Don’t you see the ECB’s independence at risk?

In the crisis many people wanted the ECB to be on board. But I would say that we should keep our distance to the political processes. This is also reflected in many decisions: For example we do not buy government bonds of a country under a rescue program as long as this program is under review.

But is there really a distance if the ECB - through the purchase of government bonds - becomes the biggest creditor of the Euro area member states? The President of Bundesbank, Jens Weidmann, says it blurs the line between fiscal and monetary policy.

Jens Weidmann is a highly respected member of the Governing Council and this is a very good point. But it is not the case that the governments drive us. There is no “fiscal dominance”. We decide on our monetary policy absolutely independently.

Some experts even argue that a central bank solely focused on the stability of money is no longer up-to-date.

First of all: Price stability is our primary mandate. But as long as price stability is not at risk the EU treaty foresees that the can support the economy more general. But more generally speaking: The best contribution that central banks can make to sustainable growth and employment in the long-term is to guarantee price stability.

At the moment central banks worldwide are very much concerned about increased uncertainty and volatility in financial markets. But is higher volatility not usual in a situation in which we stand on the cusp of changing times due to the upcoming lift-off by the Fed and isn’t it a problem if monetary policy always steps in as soon as there is stress?

You are absolutely right, higher volatility is nothing abnormal when you have reached a turning point. And it is definitely not our task as a central bank to react to every single market fluctuation. But uncertainty and volatility can have negative impact on the real economy if they last for a long time. We have to monitor that very closely.

Another topic: In the Greek crisis there was – for the first time ever – a public debate about a country leaving the Euro area. What are the implications for the monetary union and for the ECB?

I have been to Greece recently right after the election. My message was pretty clear: Greece has to deliver now! There is an agreement and it has to be implemented completely. The European institutions and the member states have gone to their outermost limits. To implement the agreement is the best that the decision-makers can do for their country and for Europe. But what has happened in Greece recently will stay in everybody’s memory.

Some observers argue that the discussion about a Grexit has also put into question the irreversibility of the Euro.

I would say let’s not put into question the irreversibility of the Euro. And I don’t think that this has happened. We had some specific problems with a single country. And my impression is that other countries have learned their lessons: Don’t get so far. It is much better to solve your problems earlier and on your own – before all the others also sit at the table and interfere.

What lessons should be drawn for the monetary union? The five EU Presidents have called for much more integration and centralization – culminating in the call for an EU finance ministry. Bundesbank President Weidmann has criticized that the proposals lack the right balance between common liability and control.

The most important steps we need to do now are the full implementation of the banking union and the capital markets union. Already at the time when the monetary union was created a lot of experts said that these parts were missing – but this was neglected. But is has proven to be a fallacy to think that every country could deal best with its banks alone. We need common rules. With the capital markets union we will get – via the financial markets – a better risk sharing across countries. This is very important. Another issue is the question. How far can we get with the fiscal union?

And what is your answer?

A fiscal union is an intellectually interesting concept and I’m not against more integration in the area of fiscal policy. But this does not work without strong democratic legitimacy. But such big steps are not going to happen soon.

But is the monetary union viable without a fiscal union? A lot of people doubt it.

Besides the banking union and the capital markets union another precondition would be that the fiscal rules are respected. They are too complicated and they need to be simplified. But what really counts in the end is that the fiscal rules are respected. Finally we also need better discipline through the financial markets.

When you call for the full implementation of the banking union – does this also mean that you are pleading for a common deposit guarantee system in the Euro area?

A common deposit guarantee scheme would serve the aims of the banking union. But it could only be implemented gradually.

How do you assess the current situation of the European banks? In many respects they still seem to lag behind their US counterparts.

The Euro area economy is still weak, interest rates are low, non-performing loans in some countries are high – this all puts pressure on the banks. On the other hand there are also positive developments. The ECB’s banking supervision arm has concluded its comprehensive assessment, and measures to recapitalize banks have been implemented in most parts. What we need now is to harmonize the treatment of capital. There are still too many national solutions. Some banks might also need to reassess their business model. But this is not for the authorities to decide.

Many European bankers complain about too much regulation – also in comparison to the US.

There are certainly some points we have to look at again closely. One example: Under Basel III risk weights for housing are very small, but risk weights for credits to small and medium size enterprises are very high. But historically crises mostly started in the housing market. We might have a problem there. But all in all I’m fine with the regulation.

And what about the “too-big-too-fail”-problem – there has been the “Liikanen report” of an expert group you have chaired?

A lot has happened in dealing with these big banks – regarding capital requirements, resolution, TLAC buffers. But there are still cases in which an implicit government guarantee for big banks lead to cheap funding for these institutions which is used for excessive risk taking – especially when it comes to proprietary trading and market-making. We should not ignore or forget this problem. When it comes to the problem of too big to fail, we have gone a long way but not all the way.

But you don’t see a risk of overregulating banks?

Of course we must be careful not to overregulate. But you also don’t have to always buy every argument of lobbyists.