Joachim Nagel: Into the new - economic realities after the
shockwaves
Keynote speech by Dr Joachim Nagel, President of the Deutsche Bundesbank, at the
Official Monetary and Financial Institutions Forum (OMFIF) and DZ Bank breakfast
discussion, Washington DC, 15 October 2022.
* * *
1 Introduction
Good morning, ladies and gentlemen.
Time flies. We are already approaching the end of an intense week packed with
important meetings, interesting talks and valuable discussions here in Washington.
International exchange and cooperation are indispensable, since many of the current
issues and challenges have a global dimension or are even global in nature.
The forecasts in the IMF's World Economic Outlook make three things very clear: high
inflation is a broad phenomenon, affecting most economies across the world; a growing
share of economies are in a growth slowdown, and among the advanced economies,
Germany will probably be hit particularly hard; and third, global trade growth is slowing
down sharply.
However, longer-term developments such as the reorganisation of supply chains also
have a global character. The latter aspect will be my first topic. From there, I will take a
closer look at growth, inflation and monetary policy.
2 International supply chains
The new challenges we face today are the result of the turbulent times we've been
going through. In recent years, economies across the globe have been hit by an
exceptional series of shocks. Although the level of impact has differed across countries,
it has been severe for almost all. Consequently, economic policymakers are currently
being called upon to reduce the impact of these global events on inflation, growth,
welfare and inequality.
In times like these, when short-term efforts require so much focus, it's easy to lose sight
of the medium and long-term challenges. Nevertheless, these challenges do exist, and
they need to be addressed. The pandemic has made one of them painfully clear: the
fragility of international supply chains.
In spring 2020, border closures and other Covid containment measures disrupted many
value chains - not only globally, but also within the EU and its common market. In
Germany, for example, intermediate goods were no longer arriving and firms had to
make temporary cutbacks in production.
In principle, well-functioning market forces provide clear incentives for firms to make
their supply chains more resilient. Effective risk management should identify cluster
risks and one-sided dependencies.
However, recent low-probability but high-impact events like Russia's war against
Ukraine have illustrated the limitations of these market forces. Especially events with a
global reach often seem inconceivable before they happen. And at some point in the
future, another shock is going to occur which firms and governments didn't see coming.
This is why economic policymakers are rethinking elements of their strategic approach
to take account of the unexpected. The EU has formulated the concept of open
strategic autonomy. One of its main goals is to strengthen the resilience of supply
chains. The question is: how?
In my opinion, de-globalisation cannot be the answer. Reshoring production and
clustering it domestically entails high risks as well. Just imagine an earthquake like the
one that hit Japan in 2011, or a flood. We simply cannot rule out the possibility of
something interrupting production, no matter where, and diversified supply lines act as
insurance against such events.
What is more, trade offers efficiency through comparative advantages, and
deglobalisation would sacrifice that. Openness and resilience are not generally a trade-off,
but they are often complementary. As history has shown time and again, trade is crucial
to higher living standards.
Therefore, rather than turning away from world markets, it is essential to re-evaluate
one's trading partners, production networks and the terms on which trade takes place.
In my view, companies have to make these decisions themselves. It's in their own
interest to diversify supply chains and avoid clustering production in countries where
geopolitical tensions could lead to operational disruptions or closed borders. Indeed,
surveys have shown that many firms are already planning to relocate parts of their
production.
However, redirecting flows of goods may increase costs. Security comes at a price that
has to be paid. Economic policy can help to minimise these costs by providing a reliable
framework for firms. Clear and enforceable rules of trade as well as harmonised product
standards reduce the uncertainty firms face when planning their supply networks.
A common set of rules will help companies to readjust their supply chains without
forfeiting too much efficiency. Having a group of countries that share the same values
and commit to such rules will, therefore, benefit them all.
3 Inflation
Another global phenomenon is inflation. The IMF expects world consumer prices to rise
by 8.8% this year. Getting inflation under control is now a top priority.
"Inflation is not dead, but can once again become a real danger," OMFIF Chairman
David Marsh said in an interview more than two years ago. He was to be proved right.
In addition to the conflict with Russia and supply chain disruptions, high inflation is
another major factor weighing on the global economy. The outlook is very uncertain
right now. Risks to growth are tilted to the downside in all advanced economies as well
as in most other countries.
Overall, the global economy is currently experiencing a marked cool-down. According to
IMF experts, last year's global growth of 6% will be followed by a rate of 3.2% this year.
They expect only 2.7% for next year. This is 0.2 percentage point lower than in the July
forecast. Moreover, there is a 25% probability that global growth could fall below 2%.
As I have already mentioned, the growth outlook for Germany took an especially
significant hit. Uncertainty surrounding the energy supply and its costs have
increasingly weighed on investment and consumption. Economic output thus probably
declined slightly in the third quarter. The uncertainty surrounding the gas supply is
particularly troubling. Overall, real gross domestic product (GDP) could decline
significantly in the final quarter of 2022 and the first quarter of 2023. This would imply a
recession, that is a significant, broad-based and longer-lasting decrease in economic
output. IMF experts expect the German economy to contract by 0.3% next year.
The impact of the energy crisis on the euro area as a whole is likely to be somewhat
smaller, with the IMF expecting slight GDP growth of 0.5% for 2023. In addition to the
tensions in the energy market, high inflation is weighing on economic activity. Massive
price increases are a drag on private consumption in particular, all the more as it is
broadly based.
In September, consumer prices in Germany rose by double digits for the first time in
more than 70 years. According to the Federal Statistical Office, the Harmonised Index
of Consumer Prices (HICP) in Germany rose by 10.9% in September. Looking at the
national Consumer Price Index (CPI) often quoted in Germany, the increase was
10.0%. This is the highest figure recorded by the Federal Statistical Office since
December 1951.
Inflation in Germany as measured by the HICP is expected to be above 8% in 2022.
The inflation rate will probably remain high next year, too, and I think it is likely that, on
an annual average, a seven will be in front of the decimal point. This is in line with the
CPI projections of the German government and the IMF. However, here again, the
uncertainty is very high.
And given the tensions in the energy markets, there are significant upside risks to the
inflation rate. It could stay elevated for even longer. It also remains to be seen what the
gas and electricity price brake will look like. By comparison, the IMF expects the
inflation rate in the US to decline faster than in Germany, to 3.5% next year.
In the euro area, according to the flash estimate, the HICP rose by 10.0% in
September, reaching its fifth consecutive peak. What is more, the core rate came in at
4.8% in September. Inflation was thus broadly based across the euro area as well.
Inflation projections for the next two years also show figures distinctly above our
medium-term inflation target of 2%, namely 5.5% for 2023 and 2.3% for 2024,
according to the September ECB staff projections.
4 Monetary policy
The ECB Governing Council therefore acted decisively. In July, we raised our policy
rates for the first time since 2011. The increase by 0.5 percentage point brought the
chapter of negative deposit rates to a close. In September, we followed this up with an
even larger interest rate hike of 0.75 percentage point.
Further interest rate hikes will be needed to bring the inflation rate back to 2% in the
medium term - not just at the monetary policy meeting at the end of October, in my
opinion. The size of the interest rate steps and how high we raise interest rates will be
driven in each case by the current data and their importance for the inflation outlook.
In any case, the ECB Governing Council must not let up too soon. Because we have to
make sure that the high inflation ends. The longer inflation remains high, the greater the
risk that longer-term inflation expectations will rise above the Eurosystem's target. If
inflation expectations were to de-anchor to the upside, interest rates would have to rise
even faster or higher. And the macroeconomic costs of bringing inflation back down to
the desired level would be higher as well. This is a scenario that we on the ECB
Governing Council absolutely want to prevent.
As monetary policy continues to normalise, we will also need to look into scaling back
Eurosystem asset holdings, which amount to almost €5 trillion. I am committed to
addressing this reduction on the Governing Council in a timely manner, as there is more
to monetary policy normalisation than just raising key interest rates.
5 Conclusion
Ladies and gentlemen,
Let me conclude.
The pandemic and the Russian war of aggression have confronted the world with tough
challenges. I have sketched two of them. First, businesses have re-learnt the need to
diversify supply chains and avoid clustering activities in countries where geopolitical
tensions could lead to operational disruptions or closed borders. Second, high inflation
is weighing on economic activity and on private consumption in particular.
Policy can help to cope with these challenges. Economic policy can support the
development of more resilient supply chains by providing a reliable framework for firms.
Monetary policy can prevent high inflation from becoming entrenched. Price stability is
the primary objective of monetary policy in the euro area. People are expecting us to
act, and that's what we're doing.