Joachim Nagel: Are we there yet?
Keynote speech by Dr Joachim Nagel, President of the Deutsche Bundesbank, at the
33rd Frankfurt European Banking Congress, Frankfurt am Main , 17 November 2023.
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1 Introduction
Ladies and gentlemen,
I am very happy to be here again. Let me begin by thanking the hosts of the European
Banking Congress for giving me the opportunity to speak to you. It's a pleasure to
address such a distinguished audience.
Do you know what "postprandial somnolence" is? In everyday language, it is also
referred to as "after-meal sleepiness" or "food coma".
While researchers still don't fully understand why people feel exhausted after lunch,
there are several explanations. One is the redistribution of the blood flow. When eating,
blood is redirected from the brain and muscles to the digestive system. This can make
us feel drowsy and less alert.
Another is that the consumption of large amounts of carbohydrates and fats leads to a
rapid increase in blood sugar levels. When those levels suddenly decline again, this can
produce a feeling of fatigue as well.
In a sense, digesting can be seen as a transmission mechanism, as it is a process that
converts food into energy.
I am not a nutrition expert, of course. So I will focus my remarks on a transmission
mechanism that I'm more familiar with, the transmission of monetary policy.
Nevertheless, I hope that - after the lunch break - you will not fall into food coma during
my speech.
2 The monetary policy response to the surge in inflation
Last year, we saw the highest inflation rates in the euro area since the introduction of
the single currency.
This surge in inflation called for a decisive monetary policy response, and that is what
the Governing Council of the ECB delivered. Between July 2022 and September 2023,
we raised the key ECB interest rates by 450 basis points. That's the steepest rise ever
in the history of the Economic and Monetary Union.
Headline euro area inflation has fallen back significantly from its double-digit peak in
October 2022. This is mainly the result of lower energy prices, but it is also due to the
steps that have already been taken to tighten monetary policy.
So are we there yet? Have we seen the peak in interest rates?
That is not clear yet.
Currently, with a headline rate of 2.9% and a core rate of 4.2% in October 2023,
inflation is still too high. The Governing Council is committed to bringing inflation back to
our 2% medium-term target in a timely manner.
Based on our current assessment, we consider that key ECB interest rates are at levels
that will make a substantial contribution to achieving this goal. Provided they are held at
these levels for a sufficient period of time.
Our future decisions will continue to be based on our assessment of the medium-term
inflation outlook in light of the incoming data, the dynamics of underlying inflation, and
our assessment regarding the strength of monetary policy transmission.
As regards the inflation outlook and the dynamics of underlying inflation, the September
staff projections do not see inflation rates returning to about 2% before late 2025. But
those numbers were published before the terrible events in the Middle East. The
associated geopolitical tensions make the medium-term outlook more uncertain.
Incoming data and the December projections will provide important information for our
decision-making at the next Governing Council meeting.
3 The transmission of the recent policy tightening
As regards the strength of monetary policy transmission, a handful of indicators cannot
paint the full picture. In the following, I will share my view on how the interest rate hikes
are currently being digested, and whether fears of overtightening might be justified.
Monetary policy transmission is a complex process, with a whole host of "channels" at
play, including the exchange rate channel, the inflation expectation channel and the
credit channel.
Transmission is also characterised by variable and uncertain time lags. Quite how
monetary policy actions impact on the economy and the price level is always difficult to
predict. And, given the highly uncertain external environment, the unprecedented
monetary policy tightening, and possible changes in the behaviour of firms and
consumers in the context of high inflation, it may be even more difficult at present.
Moreover, structural differences across euro area economies mean that the single
monetary policy does not have the same effect on prices or output everywhere. Rather,
the impact differs from one country to the next. In Germany, for example, interest rate
changes have a stronger effect on real GDP than they do in Spain, say, as recent
Bundesbank research has shown.1
This could be the result of the more prominent role of interest rate-sensitive sectors in
Germany, a more flexible labour market, a stronger focus on exports, or greater
competition in the banking system. By contrast, the price level response is stronger in
Spain than in Germany. And in Italy and France, by the way, it is somewhere in
between.
The most prominent channel of transmission is the interest rate channel. And especially
in the bank-based euro area, interest rate pass-through by banks is of particular
importance.
So far, we have seen a faster adjustment of interest rates in banks' lending than in their
deposit business. As an aside, this resulted in higher interest margins, bolstering banks'
profits. Lending rates have risen significantly, for loans to enterprises and housing loans
alike.
The tightening of monetary policy is reflected in both lower credit demand and a drop in
the credit supply. Yet, the slowdown in lending is in line with what our models would
have suggested based on patterns observed in the past.
Concerns that tighter credit supply conditions could amplify transmission have not yet
materialised. Nevertheless, we are carefully observing the incoming data, including
from the Bank Lending Survey. Thus far, the tightening has remained within the
expectable range.
As far as deposits are concerned, we need to make a distinction. Interest rates on
overnight deposits have barely increased since monetary policy tightening began.
Since July 2022, banks have raised these rates, on average, by a meagre 30 basis
points or so. This is less than what historical patterns would suggest. I know a lot of
bank customers who are disappointed by this.
Interest rates on time deposits, by contrast, have risen significantly and in line with our
model forecasts. This has resulted in substantial shifts of funds out of overnight
deposits into time deposits.2
But even so, there is still a large stock of overnight deposits. That really is quite
remarkable. One might have expected to see larger shifts into more profitable, but
equally safe investments.
It remains to be seen whether competition for customer deposits will cause overnight
deposit rates to rise more noticeably in the future. For the time being, banks are
obviously benefiting from their retail customers' sluggish response.
In addition, banks are less reliant on customer deposits than they used to be, given that
they still have significant excess reserves with the Eurosystem. Which are remunerated
at the ECB's deposit facility rate.
The remuneration of reserves is part of our monetary policy toolkit. Recent Bundesbank
research has shown that the remuneration of reserves itself may have an impact on
transmission.3
That has to do with another transmission channel, the balance sheet channel. Monetary
policy tightening is usually accompanied by a decline in the net worth of banks; this can
be reflected in lower stock prices. And banks with a lower net worth tend to decrease
their credit supply.
However, the authors show that banks with large amounts of excess reserves benefited
significantly from the rise in remuneration. These institutions saw a far stronger rise in
their net interest income - and ultimately their net worth - than their peers with low
reserves. And the authors find that the loan supply of those banks reacted less strongly
to the recent hiking cycle than the loan supply of banks with low reserves.
In other words, the increasing remuneration of reserves may impede transmission, all
else being equal. The minimum reserve requirement is a tried and tested monetary
policy instrument that could help to counteract this effect.
At this point, I see no reason to rule out a moderate increase to improve the efficiency
of monetary policy. Just to remind you, over the first 13 years of the euro, the minimum
reserve ratio stood at 2%.
For a comprehensive assessment of transmission, it is not sufficient to analyse the
interest rates on banks' new business. What also matters is how long it takes for
changes in interest rates to feed through into outstanding loans.
During the low interest rate period, many borrowers arranged long interest rate fixation
periods with their lenders. This will shield them from higher interest rates for some time
to come.
While this may be positive from a financial stability perspective, it is slowing monetary
transmission.
All in all, though, we can conclude that transmission across financial markets is
currently working well. There can be no talk of overtightening.
Having said that, it is clear that financial transmission is only the first stage of the
process. The second stage is transmitting the impulse to the real economy, and
ultimately to prices.
If monetary tightening is supposed to reduce price pressure, a dampening of aggregate
demand is inevitable. From this perspective, it is encouraging that the monetary
tightening is affecting the real economy.
Nevertheless, dampening aggregate demand does not necessarily mean inducing a
recession. I am optimistic that we can avoid a hard landing of the economy, because
several factors are moderating transmission: unusually stable, and also tight labour
markets, favourable indebtedness levels among firms and households, and strong
investment activity.
According to Bundesbank model estimates, the tightening can be expected to have its
maximum impact on economic activity in 2023 already, and on inflation only in 2024. In
other words, much of the inflation-dampening effect induced by monetary tightening is
yet to materialise. But we need it to materialise. And it will only materialise in full if we
let it work.
Against this backdrop, it would be unwise to start cutting interest rates too soon. That
would be like switching off the oven before your Christmas biscuits are done. Once you
notice that they are underbaked, you have to heat up the oven all over again and end
up using a lot more electricity.
Now we need to be patient and stay the course to reap the benefits of the tightening in
terms of disinflation. Key interest rates will therefore have to remain at a high level for a
sufficient period. While it is impossible to predict exactly how long this period will be, it
is highly improbable that it will end anytime soon.
4 Conclusion
Ladies and gentlemen,
At the beginning of my speech, I mentioned that the exact causes of "food coma" are
unknown. But rest assured, there is some helpful advice on how to prevent tiredness
after a meal. Eat less, choose low-carb and low-fat foods, and even engage in some
"postprandial perambulation" - that's taking a brief walk after eating, by the way!
And there is also some good advice as regards combating high inflation. The best thing
is to tighten monetary policy and to not give in - until a timely return to our price stability
target is ensured.
To avoid the economic damage caused by inflation being too high for too long, we need
to restore price stability. As of now, it is too early to declare victory over inflation.
In any case, we must not loosen policy until we are absolutely certain of returning to
price stability on a lasting basis. That's why "Are we there yet?" - the title I gave to my
speech here today - is a question I would rather frame in the context of restoring price
stability. And my answer to that would be "no".
Will we get there? Yes. We will.
1
Deutsche Bundesbank , Heterogeneous impact of monetary policy in the euro area?,
Monthly Report, September 2023, pp. 37-60.
2
Deutsche Bundesbank , Developments in bank interest rates in Germany during the
period of monetary policy tightening, Monthly Report, June 2023, pp. 39-62.
Fricke, D., S. Greppmair, K. Paludkiewicz , Transmission of interest rate hikes
depends on the level of central bank reserves held by banks, Bundesbank Research
Brief, 61st edition, October 2023.