Joachim Nagel: High inflation, weak growth - the priorities of
monetary, fiscal and economic policy
Speech by Dr Joachim Nagel, President of the Deutsche Bundesbank, at the
Bundesbank's Capital City Reception , Berlin, 18 October 2022.
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1 Introduction
Ladies and gentlemen,
Dear colleagues,
I would like to extend a warm welcome to you all here at the Bundesbank's Capital City
Reception.
A question to kick us off: What do ID cards, mobile phone reception and price stability
all have in common? Answer: We only miss them when they're gone.
It seems that everyone has their ID cards, otherwise you probably would not have been
able to access this event. We also have reception here this evening. But what we
cannot claim to have right now is price stability. All the more clearly do we now see the
benefits of stable money, and all the more painful is its absence.
Inflation is back with a vengeance - on a scale that hardly anyone thought possible.
High inflation is eroding purchasing power, and that is putting a considerable strain on
households. For many, surging inflation is currently the most pressing problem in their
daily lives.
The Eurosystem's central banks are tasked with safeguarding price stability. And we
are acting accordingly, with resolve, level-headedness and perseverance.
In my speech, I would first like to give a brief assessment of price developments. I will
then talk about monetary policy, before moving on to outline some of the longer-term
challenges for fiscal and economic policy. We must not lose sight of these amidst all the
short-term problems we are facing.
2 Inflation is back - and it's breaking records
In the world of sport, we are thrilled to see records being broken - like the new world
record set at the Berlin marathon a few weeks ago. Inflation is a very different kettle of
fish: this year, consumer price inflation in the euro area has climbed from one record
high to the next since the introduction of the single currency. Hitting 10%, the
September rate was the fifth all-time high in a row.
One major driver of this inglorious record-breaking spree is Russia's war against
Ukraine. But price pressures were already on the rise before hostilities broke out: the
inflation rate has been above 4% for a year now. Inflation has not been confined to
energy and food prices for some time now. Stripping out these two components, core
inflation stood at 4.8% in September. In other words, price pressures are now
broadbased.
There is also some evidence to suggest that inflation in the euro area will remain high
for the time being, with the latest ECB staff macroeconomic projection putting it at 5.5%
next year.
While most forecasts assume that inflation rates will move towards 2% again in the
medium term, merely converging on this target cannot be enough for the Eurosystem -
after all, it is vital to achieve the 2% rate in the medium term. Moreover, forecasts could
lull us into a false sense of security. Past projections have, after all, underestimated
actual price dynamics on multiple occasions.
Caution is therefore warranted here, especially as uncertainty is extremely high and
risks are clearly tilted to the upside. For example, tensions in energy markets could
persist for longer than assumed in the forecasts. Still-high commodity prices might be
passed on to consumers on a greater scale than usual. Wages could rise more sharply
than previously anticipated.
3 Monetary policy needs to step up to the plate to safeguard price
stability
In this situation, all eyes are focused on monetary policy, and rightly so. Whilst it may
not be able to lower gas prices or make butter cheaper, what it most certainly can do is
prevent high inflation from becoming entrenched. This could happen if households,
enterprises and wage bargainers keep expecting higher inflation rates in the future.
Monetary policy in the euro area now needs to step up to the plate - and that's what we
are doing. The ECB Governing Council initiated the lift-off in interest rates at our
meeting in July, and in September we followed this up with an even bigger interest rate
hike. These decisive interest rate steps are important for achieving price stability, which
is why I very much welcome the decisions.
But it is also clear that we cannot stop here. Short-term real interest rates are still very
low, in some cases even negative. In other words, monetary policy is not yet
dampening inflation, but is still driving it. Further steps along the path to monetary policy
normalisation need to be taken, then. How large the individual interest rate steps will be
and how far we raise interest rates will be dependent on the data.
It is also important to look into the high levels of bond holdings. These currently amount
to almost €5 trillion and continue to exert considerable downward pressure on euro area
bond yields. In my view, there is much to be said, then, for soon setting aside the
practice of replacing all maturing bonds. This additional tightening signal would
underscore our commitment to ensuring that inflation returns to the medium-term target
of 2% in a timely manner.
If we act too hesitantly, we run the risk of having to tighten monetary policy even more
severely further down the road. Past experience, too, has taught us that if monetary
policy gets behind the curve, medium-term inflation expectations adjust upwards. And
that would make it far more difficult for monetary policy to achieve price stability.
This is why it would be wrong to now hold back on further steps towards normalisation
for fear of a downturn. On the contrary, unrestrained inflation is itself a burden on the
economy. The longer inflation remains high, the more of a strain it places on
consumption and investment. And the greater the risk of it becoming entrenched at a
high level in the medium term. That has to be prevented from happening.
For my part, it is important that we be honest: curbing inflation also comes with a price
tag. It is likely to temporarily be an additional dampener on growth. But the main culprits
behind the economic weakness are the supply bottlenecks caused by the pandemic
and the war.
Honesty also means acknowledging that the lift-off in interest rates will make interest
rate risk materialise on balance sheets. This also affects us as a central bank: we hold
a high stock of low-interest securities with, in some cases, very long residual maturities.
The counterpart to these on our balance sheet is mainly short-term deposits of
commercial banks. The interest on these is now rising. As a result, this may weigh on
our annual results. The provisions on our balance sheet are available as an initial buffer
against potential losses arising from financial risks.
4 Fiscal policy: targeted softening of hardships
We have to recognise that the path to price stability is not a sprint but a marathon.
Unlike the runners in the Berlin marathon, we do not know from the outset how much
longer we still have to run until we reach our goal. This is especially true since monetary
policy measures do not have their full effect on inflation immediately, but only after a
delay.
To make rapid progress on this route, fiscal policy can also play a part. It is an enduring
principle that sound public finances facilitate stability-oriented monetary policy.
However, there are special challenges to overcome given current developments
surrounding the war in Ukraine and the energy crisis. As far as they are concerned, I
believe that exceptional programmes, such as Germany's Armed Forces Special Fund
and one-off measures to ease the burden presented by extreme energy prices, are also
justified.
That said, it all hinges of course on the specific design of the individual measures - and
this, too, is the subject of intense deliberations at the moment. As I see it, there are
three crucial aspects. First, the energy supply needs to be expanded as quickly as
possible. The government can help here. Second, energy demand has to decline
significantly. This is down to all of us, as consumers, but also to enterprises. The
government can promote conserving energy, and it should not, under any
circumstances, dispense with incentives to save energy. Third, the government has the
task of providing the most targeted support possible to households that are especially
hard-hit. This also applies to severely hard-hit enterprises with fundamentally sound
business prospects.
When putting together these relief measures, it is crucial that incentives to save energy
are preserved. This aspect has been picked up by the expert commission on a gas
price brake. Up to €200 billion in new borrowing has been budgeted for. The
commission's proposal is supposed to cost €95 billion. The important thing here is to
end the assistance measures as planned and not to make full use of the remaining
credit. This would also prevent fiscal policy from pushing up inflation in the medium
term and thus working against monetary policy.
Financial assistance is not a "free lunch". Because honesty also means acknowledging
that Germany is now getting poorer. The German economy is a net importer of gas,
coal and oil. And it is the prices of precisely these commodities that have risen
particularly sharply. This means that we are having to spend a larger share of our
economic output on these imports. That translates into aggregate losses of both income
and welfare that even government assistance will not be able to offset indefinitely.
The government assistance granted at present will need to be funded at a later date,
either through lower spending or higher taxes. The new borrowing shifts the burden into
the future, where it joins the fiscal strains caused by climate change and population
ageing.
For the statutory pension insurance scheme, the Bundesbank has calculated a number
of long-term scenarios and presented policymakers with various options for reform.1
National and international advisory bodies recommend linking the retirement age to life
expectancy. At the Bundesbank, we can understand this very well from an economic
perspective.
In our simulations, we calculated the effects that would result from the statutory
retirement age being linked to life expectancy as of 2031. That would leave the ratio of
contribution years to retirement years roughly constant, thus taking pressure off the
contribution rate and the Federal budget. The longer period of employment would see
both individual pension benefits and employment rise, boosting economic output and
tax revenue.
Regardless of what policymakers ultimately decide to do, their plans should be based
on long-term, plausible projections and be transparent to taxpayers and everyone
covered by the pension insurance scheme.
5 Economic policy: shaping transformation
Population ageing also poses challenges to enterprises. In the medium term, fewer
people will be available to the labour market. Future growth in the German economy is
likely to be driven mainly by advances in productivity, which makes the contributions
from technological progress and innovation all the more important.
In this context, it is encouraging to hear that business start-ups in the field of
knowledgeintensive services increased sharply last year. This could bolster productivity gains over
the medium term. The same applies to investment in hardware and software, which was
ramped up significantly by enterprises in 2020 and 2021. This undoubtedly received a
boost from the wave of digitalisation in response to the pandemic.2
The current energy crisis could also be a catalyst for positive developments over the
longer term. For example, the transition away from fossil fuels may now proceed more
quickly. This would help to achieve climate targets. And the sooner we adapt, the
sooner we will benefit from the low production costs of renewable energy.
However, lengthy and time-consuming procedures and processes are often a
bottleneck to a rapid energy transition: planning, approval and contract allocation for
investment in renewable energy must be made quicker and easier. Policymakers have
taken this into account in their "Easter package", for example, although this has yet to
prove itself in practice.
Improved framework conditions will allow the economy to undergo the necessary
transformation more easily, both in terms of energy and beyond. To enable enterprises
to plan and invest for the long term, economic policy must be forward-looking and
dependable.
In spite of all the pressing issues and crises, we should not lose sight of the longer-term
horizon. It is the developments that are taking shape there that are crucial to our
prosperity tomorrow. Today, we can set the right course.
6 Conclusion
Ladies and gentlemen,
I can assure you that this will not be a marathon speech. We are already on the home
straight.
For the final spurt, there's one question I would like to ask you: What do monetary
policy, fiscal policy and economic policy have in common? Aside from the fact that they
all operate in the same environment shaped by crises, they are all currently facing
significant challenges. And they are all confronted by difficult decisions.
However, that should not paralyse us, but serve as an incentive to act decisively. And
that brings us to the finishing line. All that remains is for me to wish you a pleasant
evening and many an interesting discussion.
1
Deutsche Bundesbank, Pension insurance scheme: long-term scenarios and reform
options, Monthly Report, June 2022.
2
Deutsche Bundesbank, Productivity effects of reallocation in the corporate sector
during the COVID-19 crisis, Monthly Report, September 2022.