Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Balazs Koranyi and Frank Siebelt on 28 August 2020 and published on 31 August 2020
31 August 2020
Could you please update us on your assessment of economic developments over the summer?
We now have the numbers for the second quarter and they showed a decline in GDP of 12.1% (quarter-on-quarter). That’s of course very large, but it’s close to our projection of -13%. If you look at incoming data, by and large they support the baseline of our June projections. It remains the case that uncertainty is exceptionally high. But overall, I believe that we are still close to the baseline. That means we expect a strong rebound in the third quarter, even if that rebound will not be strong enough to put us back to where we started. So, there will be a protracted recovery, much in line with what we projected in June.
Does that mean you don’t expect fundamental changes in staff projections on 10 September?
I don’t want to pre-empt that. At the moment, the baseline continues to look plausible. Overall, the speed and strength of the recovery will be determined by the containment of the virus. This is the single most important factor. We are seeing a certain resurgence of infections, but at the moment it looks unlikely that we are going to see a full lockdown again. This is precisely what we assumed in our baseline scenario in June.
Given all this, what does that mean for ECB policy? Are you comfortable with your policy stance or do you need to revisit it in September?
Our policies were calibrated based on the June projections. We had a big increase in the pandemic emergency purchase programme (PEPP) at that time due to a very subdued inflation outlook. Our policies are data-driven. As long as the baseline scenario remains intact, there is no reason to adjust the monetary policy stance. Of course, the projections will play an important role going forward. But at the moment the PEPP envelope looks appropriate.
The ECB accounts suggest a debate on whether the entire PEPP envelope needs to be used in full. What’s your view on this?
We calibrated the amount based on the June projections, and under that baseline scenario the envelope will be used in full. There could be surprises, both on the upside and the downside, which may mean that we have to reconsider our monetary policy stance. But at the moment, that’s not on the cards.
Interpreting your words, it appears that you remain comfortable with both the policy stance and the projections.
Yes, but let’s wait for the ECB staff projections in September.
In the account of the last meeting, you appeared to warn that some market optimism may not be justified by economic data. Where do you see undue exuberance?
We have seen a very strong recovery in global stock markets, more so in the United States than in the euro area, and we’re analysing this. It’s interesting to look at where this is coming from in the euro area. The initial drop in stocks was, to a great extent, driven by an increase in risk premia. But this has been largely reversed due to the policy measures taken on the fiscal and monetary side. At the same time, earnings expectations have come down.
Overall, what we’re seeing is that stocks are strongly driven by changes in risk premia. This means there is a return of confidence, also reflecting beliefs that fiscal and monetary policies remain supportive. On the one hand, this evolution of stock prices is good because it eases financial conditions, but on the other hand there’s a risk of repricing.
I would also like to stress that many investors remain more cautious. We have seen large inflows into money market funds and there’s strong demand for gold, which suggests there’s also demand for hedging.
The ECB’s asset purchases have come off their highs. How should we read that decrease? How much of this is seasonality and how much is improved market conditions?
We always stress that one shouldn’t overinterpret short-term changes in purchase volumes. But you are right that seasonality patterns play a role. Market conditions also play a role and they have improved quite a bit.
But you must not forget that the PEPP has a dual role. First, it has a role in market stabilisation related to the risk of fragmentation and, on that side, we’ve seen a substantial improvement. Second, the PEPP is also there to close the inflation gap created by the pandemic. If you look at this stance element of the PEPP, since the inflation outlook is quite subdued there is clearly a need to remain active in the market.
Do you expect PEPP purchases to come back into line with the capital key? Will it be at the end of the PEPP or earlier?
We haven’t discussed this. But as a rule of thumb I would say that the stronger the stance element of the PEPP, the smaller the capital key deviations. When it comes to the monetary policy stance, there is no need to deviate from the capital key. Deviations are driven by the need to counter the risk of fragmentation. As the risk of fragmentation is going down, there is less of a need to deviate from the capital key.
The PEPP was meant to counter an unjustified rise in yields. Is the current market pricing justified?
This is part of the flexibility of the PEPP, which is fundamental for its effectiveness. There’s flexibility across jurisdictions, asset classes and over time, and we’ve made use of this flexibility, especially at the height of the crisis. The initial tightening of financial conditions has largely reversed and the risk of fragmentation has come down quite a bit. Spreads have come down substantially. A good part of this is due to our monetary policy actions. But we shouldn’t forget that action on the fiscal side, especially at European level, played a very important role as well.
Is the ECB providing guidance to the EU on how to design its joint debt issuance?
We’re not involved in that process. But I’m sure the European Commission will look very carefully at our eligibility criteria. If the bonds are eligible, we can buy them, and our current policy foresees that 10% of our purchases, both under the public sector purchase programme (PSPP) and under the public sector part of the PEPP, are for supranational debt.
Once this bond is issued, should we expect a surge in purchases, or will you reduce purchases elsewhere?
The envelope is set according to our monetary policy goals. The envelope is not calculated based on issuance. It’s calibrated in order to close the inflation gap and we have rules on how this is distributed across the different segments, although there is some flexibility.
One should be aware that the largest part of the EU issuance may come after the currently foreseen end of the PEPP’s net purchase phase. But of course, the PSPP would, in any case, still be there at that time.
If the largest part of net issuance comes after the end of the PEPP, wouldn’t that mean you will be bound or pushed by markets to extend the programme?
Markets always try to push us. But we have a clear way in how we design our policy. We take the decisions, not the markets.
Do you remain comfortable with the tiering multiplier?
The introduction of the tiering system was quite a success. We managed to maintain the desired degree of accommodation while reducing the burden for banks. We could adjust the tiering multiplier as well as the remuneration of the exempted tier. But at the moment, we are looking at how the decisions that we’ve taken are working through the system. So we have not yet discussed an adjustment in those parameters. We are monitoring it and there may be a point where we decide to do something about it, but that point hasn’t come yet.
What’s your expectation for the next tender of the targeted longer-term refinancing operations (TLTROs)? And more broadly, do you think there is a need to extend the facility? Could or should the ECB make it a permanent facility?
In the first round of TLTROs at the new very favourable conditions, we saw a historically high take-up. There was a clear incentive to participate early. There will probably be some further take-up, but nothing comparable to what we saw in June. But even if the take-up in future operations is not that big, it’s important that these facilities are there so banks can be sure they have access to them if needed. There’s no plan to make them permanent, though. What is permanent in monetary policy? You have to adjust to what is happening in the economy.
The euro has appreciated substantially, both against the US dollar and also on a trade-weighted basis. What’s the implication of this appreciation?
We are not targeting the exchange rate, but we are monitoring foreign exchange developments. My reading of the depreciation of the US dollar is that it is also a sign of the return of global confidence. What we have seen is a reversal of previous safe-haven flows. This is actually a good sign. For the euro area, I think another positive development is that the agreement on the EU Recovery Fund has increased confidence in the stability of the euro area. This would also have a strengthening effect on the euro exchange rate, even though I would say that this effect is smaller than the global confidence effect.
How all this translates into inflation is not entirely clear. We know that the pass-through of exchange rates depends very much on the circumstances and the underlying shocks. I would also be cautious in interpreting the exchange rate changes in isolation, because research shows that if there is a depreciation of the US dollar, this tends to boost global trade and global growth. So even though there may be a competitiveness effect for euro area corporates, there is an effect working through global trade, which may actually compensate for that. At the moment I am not worrying too much about exchange rate developments.
The outcome of the Federal Reserve’s policy review implies that it will be raising interest rates slower than in the past, and this could also lead to a depreciation of the US dollar. What’s your initial view on the outcome of the Fed’s review?
I am not commenting on what the Fed has been doing. They have done, as we are going to do, a comprehensive review. And I am sure they have done a very careful job in trying to find out what is the best thing to do for the Fed. But let me also stress that what is best for the Fed is not necessarily best for the ECB, because we have a different economic structure, financial sector structure, history of monetary policy actions and mandate. That being said, there is global interdependence.
Will you change your inflation target as part of your own review? Will it be more symmetrical?
The review is now starting again and I cannot pre-empt the results. But we said from the very beginning that this review will be comprehensive and open. We will consider all the options. That means that we are also open to adjusting our definition of price stability, but I cannot tell you how. I think it’s clear that the medium-term perspective has served us well. I would think this will be maintained. I would also say that communication matters a lot, even more than in the past. So I think we should have a target that can be easily communicated.
Climate change has gained more prominence in the review. What can you do on the market side to promote green assets? You said in the past that you would not favour skewing asset purchases towards green assets. Do you maintain this view?
Climate change is probably the biggest challenge we are facing, much bigger than the pandemic. The pandemic has shown what it means to have a severe global shock that hits the entire world simultaneously. This also has implications for the question of how to deal with climate change. We have seen that even though this health shock was entirely unrelated to monetary policy, it nevertheless has huge implications for monetary policy. The same is true for climate change and this is why central banks cannot ignore it. It is such an important challenge and it has direct effects on our ability to maintain price stability. This is why we have to ask ourselves what we can do within the boundaries of our mandate. This is also why we think climate change should play a prominent role in the monetary policy strategy review.
There are some areas that are uncontroversial. For example, the investment of our own portfolio, of course we can do a lot there. We also have to start to integrate climate risks into our economic models and see how that works out. We have to think about climate risk assessment, which has potentially big implications for banking supervision. It can also have implications for the setting of haircuts in our collateral framework. This is another important area that I think should be rather uncontroversial.
The most controversial part is probably the question that you raised, whether purchases for monetary policy purposes should be biased towards green bonds. The first thing to note is that, at the moment, the scope for that is limited because the green segment in the bond market is very small. We are already holding around 20% of the eligible green universe. Therefore, the most important thing is that there is more issuance of green bonds, which would then automatically lead to higher purchases of green bonds.
One idea that I have been pushing a bit in recent months is the idea of a green capital markets union. The idea is to combine the whole reform process for capital markets union with the green transition. I think there is a huge potential there for Europe. It would help a lot and would also – in an uncontroversial way – allow us to buy more green bonds.
The question of whether we should bias our purchases will have to be discussed. There are different views. There is the view that we should stick very closely to market neutrality. And there is the alternative view that markets are not pricing climate risks properly, so there is a market distortion and therefore market neutrality may not actually be the right benchmark.
My thinking about this is also developing and we will have to have that discussion in the monetary policy strategy review.
Could you change the eligibility criteria for bonds in your collateral framework to shift towards a “greener” policy? This could be done, for example, by clauses which make assets eligible only if the issuers have stated their climate risks clearly.
I think that is an interesting idea. Whatever we want to do in that area, we first have to understand what “green” actually means. First steps have been taken in the context of the EU taxonomy. But much more is needed. The second thing we need is disclosure. What you said is basically that, even if we don’t go as far as saying that certain companies are excluded, we could at least require disclosure as a first step.
Could you give us more of your thoughts on the green capital markets union?
Capital markets union is an area where there is broad consensus, but progress has been relatively slow. The reason for this is that we have financial structures in place that work reasonably well, so it’s difficult to shift towards a new system that is more market-based. But in the context of the green transition, we will have to rebuild financial markets in a green way. There will be a kind of copy of the existing financial markets in green. And when you build something new, that is much easier than changing a system that is already in place. I think this would really be a big chance for the EU to move in this direction.
What are your broad conclusions about the pandemic’s impact on our economy?
We are facing a tremendous shock, and this shock has long-lasting structural effects. This of course has an important impact on our monetary policy. Research shows that pandemics are historically followed by a further fall in the natural real interest rate. And this poses a challenge for monetary policy because this then means that we are again pushed towards the lower bound. We have to take that very seriously. This is also why I think the pandemic will have an important impact on the monetary policy strategy review. The macroeconomic backdrop has changed quite a bit since the previous review in 2003. Now there is another change and therefore this will have an impact.
Research actually shows that the natural interest rate decreases for a very long time after pandemics. Are you concerned about this?
This is not a given. Whether this happens depends, crucially, on how policy reacts, especially fiscal policy. This is why I think the EU Recovery Fund is so important, and in particular whether this money is spent wisely on projects that raise potential growth and foster the green transition and the transition to a digital economy. But it could happen if the policy response is inappropriate.
There is renewed discussion about TARGET2 balances. Do you still agree that a rise in German claims is mostly a factor of the asset purchase programmes?
The quick answer is that TARGET2 balances are very much in line with what would be expected from the asset purchases. I do not see any deviation there. There is also no evidence of continued capital flight from TARGET2 liability countries. In June, there have actually been net debt inflows. That means this is nothing we should really worry about.
Do you expect to meet in person in September?
The original plan was to meet in person. This may have to be revised.