Philip R Lane: Q&A with Reuters
Q&A with Mr Philip R Lane, Member of the Executive Board of the European Central Bank,
conducted by Mr Daniel Burns, at Reuters Newsmaker, New York City, 27 September 2019.
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The following is a transcript of an on stage question and answer.
Let me welcome Philip Lane, Member of the Executive Board of the ECB. That's a role
he went to earlier this year having served as the Governor of the Central Bank of Ireland
since 2015. He has been an adviser to other international economic organisations, such
as the IMF, OECD, World Bank and Asian Development Bank. He has a PhD in Economics
from Harvard and earned his BA from Trinity College Dublin where, until recently, he was
the Whately Professor of Political Economy. I'm also told he is a Liverpool fan, so he is
riding high early in this Premier League season and we'll see if that confidence extends
to team ECB. Mr Lane if you'd like to start.
One reason I suppose that I wanted to talk here this morning was to further explain the context
for our recent monetary policy decision. So if you look back over the last few years, if you look at
the period from 2014 to 2018, essentially, the decision in 2014 by the ECB to tackle the risks of a
slow-growing economy and the deflation risk in the euro area meant that during those years,
from 2014 to 2018, what we saw was a fairly significant recovery. We had a big decline in
unemployment in Europe, a very strong record of job creation and a significant stabilisation of
inflation. So compared with the period in 2014, when deflation risk was on the horizon, there was
a significant recovery in the inflation process through that period. And so to more recent
monetary policy history, at the end of 2018 the decision was made that enough progress had
been made in bringing inflation back towards the target that we would end the net asset
purchases. Now in September 2019, part of the package that we announced a couple of weeks
ago was: we did a small policy rate cut - the deposit facility rate went from -40 basis points to -
50 basis points, we provided reinforced forward guidance and we restarted the net asset
purchase programme (APP), running at €20 billion a month. So you may ask: why was that
necessary? Well, when we made the decision last December to end net purchases under our
APP, the 2021 inflation forecast from the perspective of December 2018 was at 1.8%, so close
to 2%. But what's happened this year? In March there was a significant downgrade in our outlook
and that's essentially been confirmed in June and now in the September forecast. So now, as of
September 2019 before we made this policy decision, the 2021 inflation forecast was 1.5%. So
compared with 1.8% that's a big movement, from 1.8% to 1.5%. In that context, the decision was
that we needed to revise our policy stance, which as I say is a rate cut, reinforced forward
guidance, reopening of the APP and then there's the redesign of our targeted lending facility and
the introduction of this new tiering system for how banks will be exempted, to some extent, from
the implications of negative interest rates on their excess liquidity.
So what we have is a very unusual situation, which is that many of the reasons why we were
optimistic in 2018 remain. The labour market remains strong, services remain strong,
consumption remains strong, household investment remains strong. So where's the decline?
Essentially, manufacturing. So it's a very unusual, sector-specific asymmetric slowdown at the
moment, which is not general across the economy but very, very visible in manufacturing. Of
course, when you start to look at that - yes there are Europe-specific issues - but a lot has to do
with the slowdown in global trade, which is some mix of trade policy, a kind of revision of the
speed of growth in Asia, in particular, and related issues. So it's a very unusual situation. It's very
important to say this is really not a dramatic policy move, it's a recalibration. We're not saying
that there's a serious recession risk, we're not saying that there's a serious derailment of
inflation, but there was a need to make a correction. And the last point I'll make in this opening is
that it's very important in these circumstances that you do respond. When you do have inflation
below the target, when you already have done a lot of accommodation, it is important, not to
react to every little blip in the data. But when you see a significant deviation from the target it's
important to respond, and that's what we've done.
Thank you for laying out the context. So eurozone data continue to be skewed to the
downside, particularly in Germany, where there seems to be a risk that this broad
industrial weakness could be slipping into services. How significant is that? Is there a
case to be made that Germany is already in recession?
So let me make two points about that. One, Germany of course is very much an anchor country
for the euro area, but Germany has a really unusual economic structure. It is not representative
of the wider euro area because it's such a manufacturing powerhouse. So the manufacturing
slowdown is disproportionately affecting Germany. At the ECB we look at aggregate euro area
data, we don't go country by country, it's the aggregate that matters. So of course Germany is a
significant factor but it's not the case that... so I think it would be a mistake, in fact I see it every
day, it's tempting to read the German headlines and say this is a proxy for the euro area. But
when you have a shock that is specific to manufacturing and when Germany has a much bigger
manufacturing sector than, say, France or Spain in proportion, it would not be a good idea to
extrapolate. When we say services are resilient, of course those service sectors which are
selling to manufacturing are affected, there's no doubt about that, and then of course the spillover
to the wider economy will be stronger in Germany than elsewhere. Let me also emphasise,
though, that it remains the case that Germany, even with the slowdown (because remember they
had such a spectacular performance in terms of the export dynamo for so many years)... So
going back to 2018, 2017 was just an exceptional year, there was a slowdown in 2018 but by and
large 2018 was just a little bit of a correction, returning to a more typical performance. What's
interesting going from 2018 to 2019 is it's more than that, it's more than just slowing down from a
kind of exceptional performance in 2017, but it's still the case that it's important to view this as an
intermediate situation. There are definitely danger signals, I agree with you, there's a downward,
we say it as well, there's downside risk, there's more downside risk than upside risk for obvious
reasons, but the central forecast remains intermediate. The European economy will grow, we
are projecting inflation to continue to increase, the labour market is very strong, wages are
growing at quite a clip now. So it's a case where we just need to reinforce that by this extra policy
move rather than some diagnosis or some major serious movement towards overall recession.
Individual countries may tip for a while, but not the overall euro area, we don't see it.
So I believe the staff forecasts for the near term have the aggregate growth rate
balancing around 1%, a little bit above, for the near term. Is that too optimistic?
So as a central forecast, I think the staff work hard to make sure that they strike a balance
between optimism and pessimism. I think it's a reasonable central scenario. But a lot of risk in
the world is a little bit bimodal. One of the issues we look at, of course, is trade policy. So the
question is will these global trade disputes... Are they going to stagnate? Are they going to
escalate and widen to a bigger trade war issue? Or will there be deals? If there are deals, that's
upside risk. If it's basically stagnating, stalemating, that's kind of behind the central forecast. If it
accelerates, then that's a downside risk. A local issue in Europe, of course, is Brexit, where there
remains a lot of uncertainty and, clearly, if there's a no-deal Brexit that's going to be a downside
risk. So there are obvious clear events, but these events will be realised one way or the other. So
when you have political economy uncertainty either, well, I mean there are always three
outcomes. Either the uncertainty persists, and that's essentially part of 2019. Remember, the
original Brexit date was March, end of March. And it's good news that there wasn't a hard Brexit
in March 2019. But, of course, in the absence of knowing the final outcome that is a source of
uncertainty. The trade disputes and so on have been ongoing, the time by which these will be
resolved remains unclear. I remember, this time last year when the deal between the United
States, Mexico and Canada was emerging: that was an upside risk. I mean that could have gone
differently. So let's see what happens. I'm impressed by how the staff go about their forecasting
exercise. They have no incentive either to be excessively optimistic or pessimistic in terms of
their own professional standards. But there are clear downside risks. And we can all probably
have different views about how likely those scenarios are.
Speaking of policy response tools, there's a global conversation among the developed
world central banks right now about the efficacy of their tools. Your response: a 10 basis
point cut, a modest uptick to restart QE. But the tiering is something that seems in its
early days to be playing out with some unanticipated consequences and in parts of the
eurozone it seems to have the... to be viewed as effectively a rate increase, and you've
got an incentive for bank arbitrage rather than providing funding for the real economy.
Let me address the tiering issue in a minute, but before I get to that, this issue about
effectiveness. It's very important to put the deposit rate cut of 10 basis points in the context of the
forward guidance. And you also have to be able to reconcile what is the connection between
these policy moves and the underlying reality, both in the euro area and here in the United States.
We've had this really big move in long-term rates over the course of 2019. So if you believe
monetary policy had no impact on financial conditions, it's hard to explain why bond yields moved
so much this year. I mean, to a degree of course there's risk premium and so on, but the market
understands and you can see it in the forward rates, the market understands that we have the
capability. As of now we've got the rate where it is, but we clearly signal that, if needed, if there's
further downgrading of the inflation outlook which is perceived to be persistent and requires a
response, we can do more. So when we think about what matters for the real economy - the
lending rates that banks and other intermediaries offer to firms and households - it's not just the
short-term rate, it's the rate they expect this year, next year, over the next five to ten years. And
when they know that we have the capability to push that even more negative, and the capability
through the APP to compress the term premia we are seeing - and this is why the package is
there - we do of course study whether this is passing through to the real economy. Are we
seeing the lending rates come down? We are, and we know that the financial conditions, in all
the data we have, absolutely do move the dial in terms of consumption, investment, pricing
pressure and so on. So our assessment is that our tools remain quite effective. Of course, it's
quite different now compared with 2014 when, on top of the normal transmission, you also had
the issue about financial frictions. In the same way, in the United States they had this consensus
that the most powerful quantitative easing programme was when the mortgage-backed
securities market was broken in the United States back in the crisis. So we don't have that, but
it's still the case that we assess that these are quite effective tools.
If I come to tiering... Of course, for those involved in interbank markets and so on, this is
something that has led a lot of people to study this. The bottom line is that tiering was calculated
based on six times required reserves. This leaves a lot of excess liquidity. When you've got a lot
of excess liquidity left over, essentially all of the economics, and all of the evidence from every
money market you can look at, says that the interbank money market rates will be anchored by
the deposit rate. So when this is announced, and maybe in some segments when, as you say,
banks are trying to calculate what does this mean in terms of my position and so on, we could
perfectly understand and anticipate some degree of trading between those banks with a lot of
excess liquidity and those banks which don't have six times required reserves in terms of
liquidity. But this is, if you like, "infra-marginal", it's not the marginal trade that matters. The
marginal trading is what matters for pricing and for financial conditions. If there's some degree of
trading across banks to optimise these liquidity ratios, that's just part and parcel of the dynamics
of money markets. But it's a sideshow. We of course have read some of those reports as well. It
really is the case that, in the vast majority of money market segments, there's complete pass
through. You can find semi-traded low liquidity minor segments which, temporarily, may have
had partial pass-through, but in the grand scheme of things this is a minor issue; there's been
complete pass-through.
Is it your expectation that tiering is going to be successful in buffering consumer rates
from unwanted outcomes?
The motivation for tiering is, essentially, in a world where... I wouldn't want to take a position
about the extent to which banks can pass through negative rates to depositors. But to an extent
there is some friction where the net interest margin is compressed - they can't fully pass through
these cuts to depositors. The role of tiering is to basically strike a balance, where the ability of
banks to sustain credit is what we care about, we don't take a direct view about what's in the
interests of bank shareholders, that's not our concern. Our concern is whether there are risks to
the credit transmission channel. By tiering, by providing some relief in terms of the net income
effects of our policy moves, we think it gives protection against any risk to the credit transition
channel. It's not the case that it's a situation about making a call about what type of depositors
should be protected. Banks may do so, in terms of their own strategy, in terms of who they want
to protect and who they want to pass the deposit rate cut through to. That's a commercial
decision.
On efficacy of tools, I believe the latest TLTRO auction at -50 attracted almost zero bids.
We also had a fairly hefty prepayment of bonds coming due, so you actually had balance
sheet shrinkage in the near term. Do you expect that to be corrected? And to what
degree do you expect it to be corrected with the resumption of the APP?
Let me make two points. One is that the recent TLTRO take-up was based on submissions
before the policy move. So it is nothing to do with the new policy because the submissions came
in before we made our announcement. I think what's important with the TLTRO programme is
that it's a facility. The most obvious interpretation if there's a low take-up is that financial
conditions are so great that there's no need to come to the ECB for funding. It's always been the
case that TLTRO take-up has varied quite a bit across banks depending on their ability to raise
money cheaply in the wholesale markets. So I wouldn't draw a direct conclusion. We do expect a
significant TLTRO take-up over time based on current conditions, but the degree of take-up is not
in itself an indicator of the policy stance., because if the reason why TLTRO funding is not taken
up is just that they can raise a lot of cheap wholesale funding, the same outcome is delivered -
we're making sure that financial conditions are so accommodative that banks are able to pass on
cheap funding to the real economy.
Turning to inflation, is there an argument to be made that, in December last year,
inflation, the outlook at 1.8%... What is it with you central bankers where you want to treat
the inflation target as a hard ceiling and you begin withdrawing liquidity as you approach
it? Isn't the natural response then to begin retreating from it, as we've seen globally in
developed economies?
It's very important to say that the way the APP works is, basically, mostly through a stock effect.
And remember we are reinvesting. So the way I would think of the decision last December to
stop net purchases is not to start... it's the end of loosening. So, in other words, if you say we're
going to maintain this stock at roughly 2.5 trillion, and you're reinvesting, that is not a tightening
because you're basically saying we have loosened conditions so much, we want to maintain this
super-easy monetary policy. So it wasn't a tightening move at all. Tightening would be to do
balance sheet contraction plus lifting policy rates. It is basically saying we think the amount of
loosening is now where it should be. We're going to preserve it; we're going to preserve this
super-loose condition. What we've done now is we've had a revision, a review - well actually
maybe we need it even looser. And that's a reasonable reaction function. When you have the
inflation forecast going from 1.8% to 1.5%, you can't be indifferent about that. That's a significant
move and the world needs to understand that we will be responding to these significant
downgrades by making sure the monetary conditions are sufficient; to make sure the momentum
of getting inflation back towards our target is restored.
Your observed inflation, though, is even further off target than the Fed's. What gives
you the confidence that you can, that there's the lift there to get it back up?
The cornerstone of persistent inflation pressure is what's happening to wages. A big fraction of
the overall cost base of the economy is going to be the total wage bill. Unemployment in the euro
area has come down a lot; it's now in the sevens. The history of the euro area is that when
unemployment gets into the sevens then the labour market gets hot enough that we're seeing
nominal wage increases of the order which, if they are passed through, we will have inflation
back towards our target. What's interesting is we are now happy with the wage dynamic. There
was a period when unemployment was so high, and then when unemployment was falling, that
there wasn't much by way of wage expansion. Now, in the last year or two it's significant. We are
seeing wages growing, but with the uncertainty we think there are understandable reasons why
firms, for now, are absorbing those cost increases in lower profit margins rather than passing
through to prices. So under the forecast where we expect the labour market to continue to
strengthen, there is significant momentum in inflation. The remaining issue is if the trade
uncertainty, the geopolitical uncertainty is lifted, and we think... The history of squeezed profit
margins is that it doesn't last forever. Eventually, because of the economics of many industries,
firms have to raise prices. So we do think the basic inflation mechanics remain as usual and it's
just important in this period of below-target inflation that we address it through easy conditions.
It's a Philips curve argument and here it's been debated ad nauseum for the last couple
of years why we're not seeing a sufficient response in the United States to wage growth
that has been north of 3% annually for the better part of a year. Are you miscalculating
where the natural rate of unemployment in Europe is? You're at 7.5% now, does it have
to be substantially lower before you're going to be satisfied?
It's the same attitude here. If we are - and that's a good news story - if we're saying, in fact, the
European economy can sustain even lower levels of unemployment, this is fantastic. I mean the
fact that Europe, which historically has a high unemployment problem, can sustain much less...
So if you ask me, if it takes longer to hit the inflation target because the labour market turns out to
be much stronger than you thought, fantastic. People say if they look historically, and if
unemployment is at this level, historically interest rates should be higher than they are now. So
we're not going to have a kind of fixed coefficient model, where we say unemployment is this, so
that means we set the interest rate at X. We are saying that unless the inflation pressure is there
we have to keep the monetary accommodation as extensive as required. So it is kind of
unchartered territory to see unemployment come down so low without inflation, but that's not
bad, that's good. But it does require central banks to respond to that, to make sure... Because
the idea that this good news story about our strong labour markets is inconsistent with delivering
the inflation target, that would be a failure by the central banking community. The central banking
community has to make sure that its policy levers are set to make sure inflation does get to
target in this new world of better-performing labour markets.
So that's a "lower for longer" argument?
It's a very interesting phrase; you get this phrase a lot. But let me come back to the forward
guidance. I'm not making a call about how long this is going to take, because you've talked about
downside risks but it's also the case that everyone's really bad at forecasting. You know
narratives take hold - lower for longer, slow growth - and then some positive surprises can
happen. There are obvious political economy surprises - if there's a good Brexit deal, if the trade
disputes find a resolution. Then, also in the real economy, it also depends on the rate of
technological progress and other elements, which we are saying, we are noticing globally, that
the very strong tech cycle that was there in 2017 has weakened, and again maybe there's going
to be a new impetus in some of the drivers of the world economy. So our forward guidance is
essentially "state dependent", because I've an open mind about whether the world will unfold in a
positive way and this narrative will be reversed very quickly, or whether the world will be in bad
shape and we will have to respond to that. So I know everyone in all communities likes to latch
onto phrases, and "lower for longer" is definitely a popular phrase but I wouldn't be fatalistic about
it, because it does depend on important policy choices - going beyond the policy choices central
bankers make. Obviously there's trade policy, fiscal policy and so on.
The Fed as you know is in the midst of a year-long framework review, looking at the
efficacy of tools, new ways of communicating, new ways of setting inflation, expectations
and targets - and potentially price level targeting and averaging inflation. Is the ECB due
for a framework overhaul?
I think it could be good timing. It's been 16 years since the ECB did a strategy review. Most
organisations have a fixed calendar. Every three years, every five years there's some
commitment as an organisation to do a review. Now of course if you go back to 2003 when the
last review was done and if you roll forwards five years, it's 2008. There were natural reasons to
postpone the strategy review. And it's been essentially a situation where the scale of the global
crisis, the scale of the European crisis was such that this has been perpetually delayed. But I
think now it makes sense. It makes sense now when there's new leadership, when there's a
correlation. It makes sense also to learn a lot from what the Fed is doing, so there's been no
decisions made but in terms of expectation, I think there's a strong expectation that some kind of
review will be initiated, sooner rather than later.
Do you think it's realistic for the ECB to entertain a different way of approaching its
inflation target? Structurally there are clearly differences to the United States, but what
about something that is more overtly symmetric allowing it to "run hot" to make up for a
decade of cold?
There's a lot in what you said there. So this symmetry debate, we have tried to clarify it, because
we said in our July monetary policy statement that we view our inflation targets as symmetric.
That we will be as energetic... When you go back in history, in the first years of the euro the big
impetus was on convincing everyone that the ECB would not be soft on inflation. Many countries
had a history of inflation above 2% and so the main impetus was on making sure everyone
understood that above-target inflation would need a response. Now in recent years we have the
symmetric problem, which is when we are below the target. And going back, from 2014 onwards
it's been clear that the ECB has been a leader in innovating in monetary policy. Because of
course the Fed has done many things, but in terms of the nature of what the ECB has done, it's
been quite aggressive in dealing with below-target inflation. So as for symmetry, I think symmetry
is there. Now there are other elements as to how do you reinforce the inflation target, especially
when you've spent a long time away from it. The Fed had a review and there have been many,
many studies looking at the pros and cons of make-up strategies of different types. And of
course we would have a lot of people looking at these as well. Let's see what comes out of the
Fed review - it doesn't hurt us that the Fed is ahead of us, because we can learn a lot from what
they conclude. But of course I think we have to have an open mind. In the end I would share the
same general view, which is central banking by and large has a common technology, it's a
common set of challenges and my bet is central bank strategies will be broadly similar around
the world. Of course we do have to recognise the United States is much more of a market-based
financial system. In Europe banks play a bigger role and, at the level of detail, that matters. In the
grand scheme of things we had this tremendous convergence in central banking towards
inflation targeting - officially/unofficially, flexible/less flexible, so by and large central banks work in
very similar ways and I'm pretty sure that's going to continue.
But you're also, Powell has said this, central bankers are feeling they're reaching the
limits of what they can do to support their economies solely with the monetary policy
levers. You're not getting the response you'd like from fiscal authorities. What would you
advise? I mean, in Europe that governments explore finding ways to provide more fiscal
support where for more outright spending there seems not to be the willingness? In
Ireland you've got a tax regime that I think somebody has called "Ireland's gold", or
"Ireland's oil" and that's a unique opportunity there.
So let me aggregate to the euro area. So it's very important to understand the history of the last
10 years. If you compare what happened in the United States and what happened in the euro
area - given the nature of the national problems in Europe, with fiscal unsustainability in some
countries, with market speculation and so on - what you had after the global financial crisis was
a significant period of austerity in Europe. In the last two or three years, after a lot of consolidation
by governments, there's been a degree of relaxation. So fiscal policy in terms of the rate of
growth of public spending has started to be visible after a long period of, basically, being held at
zero or slightly negative. So when the private sector is doing well, the ability to run the economy
with either neutral or tight fiscal policy - I think the room was there. When you have a slowdown,
as we have now in the euro area economy, it varies by country - and fiscal policies are a national
decision. So what each country should do needs to respect the individual circumstances. But
essentially the way I would view it is that the central bank has to take macroeconomic conditions
as it sees them, and especially when the private sector is facing challenges, the overall
macroeconomic environment will be heavily influenced by the fiscal choices. And in Europe there
are various countries with strong fiscal positions. Some of these countries are also facing
slowdowns. So if the goal is to stabilise output, having countercyclical fiscal policy is important.
And so of course with a greater contribution from government spending the macro environment
will improve and in turn that's going to influence our monetary policy decisions. So I think it's
important to make sure that the current debate is primarily about stabilising the business cycle
and the text books say fiscal policy can play a countercyclical role. Historically it hasn't always
been like that. Sometimes it's been procyclical. Austerity during the crisis was procyclical in
many countries. But now, when fiscal policy is in better shape, the room to be countercyclical is
there for those countries which do have their public debt in a good situation and have a good
starting position. So what we are saying, and we said it in September in our policy statement, is
in these contexts moving fiscal policy from generally neutral, or slightly easy, to a bit more
countercyclical will be helpful.
But in the two economies I think seem to have the most room, Germany and the
Netherlands, there seems to be no willingness - particularly concerning the political will
in Germany.
I don't particularly want to comment on individual governments, but now in the autumn is when
the 2020 budgets are set. So I don't think there have been any final decisions made. Let me also
observe that of course there's a difference between the United States and Europe, which is that
by and large in European countries the automatic stabilisers are stronger. There are bigger
public sectors, tax revenues are larger. And so when there's a slowdown there's automatic
easing. I think in many countries to penetrate what is the cyclical fiscal stance requires a bit of
work, because you may have a central budget, but then you've got all sorts of different dedicated
funds. So let's see what the decisions are this autumn. But I think for the ECB we have to be
clear that we are saying that the macro situation means that a macro view of fiscal policy would
suggest that, in some of these countries, a countercyclical stance would contribute to a better
outlook for the euro area and their national economies, and in turn for the euro area.
Moving a little bit on to trade, do you see Trump's approach to trade negotiations, trade
policy, as a policy shock? This is effectively Mark Carney's argument.
Again, I don't think it's for me to comment on individual strategies. But the more general issue is
- I think there's a high consensus - over the last several years, something that was basically
unprecedented, which is the multilateral trading regime, when that comes into question, for many
businesses it's really hard to make serious investment decisions. Because, having spent many
years building global supply chains, for multinational firms having spent many years assuming
they can organise their global activities on the basis of a fixed regime, that is now in question. All I
can say is, no matter the identities of who is making the decisions, in itself the uncertainty is a
problem. And then in itself, if the final outcome is essentially increasing frictions in the world
economy, that's not welcome from an investment point of view. So let's see what happens.
Would you agree, though, with Trump's premise that China's trade relationship with the
world had to be dealt with at some point, and is it potentially even worth a recession to
bring that to resolution?
Again, I don't think I want to comment on US political economy. But more generally, my
understanding is that part of the range of issues are to do with trade per se. And then there's
other issues to do with intellectual property rights, other elements which can be handled in
different ways. Of course, the world evolves, it's not the case that you go forever without any
revision in either trade regimes or other multilateral understandings, so let's see what happens.
But I think the uncertainty in itself, if it continues to be prolonged, it's a problem.
You're about to get a new boss. As she's been on the circuit this week talking about
clouds on the horizon, trade is obviously a big concern for her. How involved is she with
you now and getting to be whe