Jens Weidmann: Are the economy and monetary policy coming out
of crisis mode?
Keynote speech by Dr Jens Weidmann, President of the Deutsche Bundesbank and Chair of the
Board of Directors of the Bank for International Settlements, at the Frankfurt Euro Finance
Summit, virtual, 28 June 2021.
* * *
Introduction
Mr Scholz,
Ladies and gentlemen,
"As a social phenomenon, an epidemic has a dramaturgic form," American historian of medicine
Charles Rosenberg wrote with regard to epidemics in general over 30 years ago. Epidemics, he
explained, begin at a fixed point in time, follow a plot line of increasing tension, then culminate in
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an individual and collective crisis before moving towards closure.
Given the immensity of human suffering brought about by the COVID-19 pandemic, we are
surely all hoping that the current drama will soon come to an end. Today's conference looks
ahead to the post-pandemic era - and rightly so, even if there is still no telling exactly when that
era might commence.
I'd like to talk about when the German economy might find its way out of the crisis, how inflation
is set to develop, and the role that monetary policy needs to play in what might be the final act of
this drama.
2 Outlook for economic activity and prices in Germany
The pandemic is continuing to shape economic developments in Germany. For over a year now,
the waves of infection and protective measures have been a key factor behind the steep
fluctuations in activity levels. But that's not to say that all economic sectors have been affected to
the same extent. You see, both voluntary changes in behaviour and imposed restrictions have
had a particularly severe impact on services sectors that typically feature high frequencies of
interpersonal contact.
On the other hand, the industrial sector, for one, has already recovered substantially from the
shock of the first wave, benefiting above all from the strong resurgence in external demand.
Overall, German economic output declined considerably again in the first quarter of 2021 as
restaurants, hotels, cultural institutions and many shops had to close.
Since then, the restrictions have already been relaxed noticeably. Setbacks are certainly still
possible, of course, and academics are warning of a further wave of infection. That said, given
the advances made on the vaccination front, it's plausible to assume, as things stand today, that
the pandemic can be suppressed for good and all key containment measures unwound by the
first few months of 2022.
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This is the assumption the Bundesbank economists have based their latest forecast on. If the
protective measures continue to be swiftly rolled back, German economic output could make a
quick recovery, returning to its pre-crisis level as early as this summer - that would be half a year
earlier than anticipated in the December 2020 forecast. In 2021, then, the German economy
could see growth of just under 4%, even increasing to slightly more than 5% in 2022.
Vibrant private consumption will be the chief driver of this strong upswing. You see, if hotel and
restaurant services and recreational facilities, say, gradually reopen their doors to the general
public, people will get a chance to consume again in establishments that once were closed.
There's also the matter of the additional savings that households have accumulated precisely as
a result of the pandemic-related restrictions that have been in force hitherto - by our estimate,
these have arguably added up to around €200 billion this year and last. According to a
Bundesbank survey, the overwhelming majority of consumers would like to use at least part of
the savings they have often built up involuntarily to purchase goods or services.
This is why the forecast is based on the assumption that around one-quarter of
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coronavirusrelated additional savings will be channelled into consumption in the next two years. It is
therefore likely that the hard-hit services sectors will catch up with industry and that the pace of
recovery in the country's economy will converge again more strongly. Overall, then, the normal
level of capacity utilisation in the German economy could be exceeded as early as the start of
2022.
Many people are worried that the spectre of inflation might return as the economy gets back on
its feet, and that's a concern I take very seriously. However, these inflationary risks should not be
overstated - in the same way that I deemed the partly excessive deflation debate to be unhelpful
in the years prior to the pandemic.
The inflation rate in Germany did indeed spike significantly higher at the start of the year, and our
economists are expecting it to climb still further in the months to come. Inflation rates of as high
as around 4% may even be possible towards the end of the year, as measured by the
Harmonised Index of Consumer Prices.
This will reduce households' purchasing power. But let's not forget that their purchasing power
was higher in 2020 due to the temporary cut in VAT rates. And there are yet more special factors
driving the increase in price inflation: the climate package, increased crude oil and food prices,
and a statistical one-off effect in the case of package holidays are just three I could mention. But
these factors will only give inflation a temporary boost.
Short-term imbalances between supply and demand might also be a factor once the economy
opens up again across all sectors. An example of this can be seen in the industrial sector, where
a surprisingly brisk global recovery has caused bottlenecks in many areas that are now limiting
production. Commodity and material prices as well as transport costs have risen sharply, and
inflation is already showing up very clearly in the producer prices for intermediate goods. These
price pressures are likely to spill over to consumer prices as well, albeit to a lesser degree and
with a time lag. Moreover, industrial goods only make up around one-quarter of the basket of
consumer goods.
However, individual services, too, might see bouts of stronger demand for a restricted supply
once the consumption backlog clears. How much consumption, when and for which goods
exactly households intend to catch up on remains to be seen. And nor is it by any means certain
that enterprises will then capitalise on any scope to raise their prices.
Either way, catch-up effects would probably not drive up inflation for good. For inflation to
become persistently too high, it would be crucial for second round effects - in the form of much
stronger wage growth or noticeably higher inflation expectations - to be at play. There are
currently no signs of this, however. This is why our experts are expecting inflation rates in
Germany to be back below 2% over the next few years. That said, this is an outlook where risks
are skewed to the upside.
3 Price outlook in the euro area
The Eurosystem staff macroeconomic projection sees prices in the euro area following a similar
pattern: the inflation rate could rise above 2% in the coming months before easing to averages of
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1.5% in 2022 and 1.4% in 2023. The flat path expected over the next two years conceals the
fact that the economic recovery is gradually strengthening the underlying upward pressure on
prices, as this is more than offset by declining energy inflation. The forecast is based on the
technical assumption that crude oil prices will fall, as futures prices currently indicate.
In my view, the risks surrounding the price outlook have shifted. Whilst it's possible that the
pandemic could flare up again if, say, there is a spread in more dangerous virus variants, the
rapid advances made on the vaccination front have reduced uncertainty noticeably. And
concerns that the euro area could slip into deflation have been dispelled.
Instead, I currently believe that the risks to price dynamics are skewed to the upside for the euro
area as well. For example, inflation would be higher if the oil price were to remain at its current
level or even climb higher still on the back of the global economic upturn. Furthermore,
policymakers could take additional climate protection measures and thereby raise energy prices.
Central banks should not just be on the lookout for potential deflationary risks; we need to be
vigilant in both directions.
Inflation is not dead, and if you're not convinced that those believed dead might still be alive and
kicking, just ask a biologist: scientists recently confirmed the discovery of a giant tortoise on the
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Galapagos Islands, even though the species had been considered extinct for over 100 years.
Claudio Borio, Chief Economist at the Bank for International Settlements, reckons that inflation is
just hibernating. The winter might last some time, but he can imagine a situation under certain
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conditions where inflation will reawaken and become a problem.
4 Monetary policy
Monetary policy in the euro area is geared to maintaining price stability over the medium term.
This is why policymakers will look through the short-term rise in the inflation rate that we are
expecting to see in the second half of the year. In light of the medium-term inflation outlook,
monetary policy will remain accommodative overall. However, a distinction needs to be made
between this general stance and the Eurosystem's crisis measures, especially the pandemic
emergency purchase programme, or PEPP for short.
I already went over the risks of government bond purchases in general and the particular flexibility
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of the PEPP here last year. In December 2020, the ECB Governing Council took the
precautionary measure of considerably increasing the envelope for asset purchases under the
PEPP and also extended the horizon for net purchases to at least the end of March 2022.
Since then, the ECB Governing Council has also explicitly linked the PEPP purchases to the
objective of keeping financing conditions favourable for the non-financial sector. Favourable
financing conditions provide the PEPP with bearings to counteract the pandemic-induced
downward pressure on projected inflation.
To this end, the ECB Governing Council considers the financing conditions for all non-financial
sectors - that is, for enterprises, households and the public sector. It also observes various
stages of the transmission process of monetary policy to the economy.
As well as monitoring various indicators, it's also important to analyse the reasons that led to a
change in those indicators, because it's not a matter of using monetary policy to cement a
particular interest rate level. The aim is merely to prevent a premature deterioration in the funding
environment, which would drag on the economic recovery and thus on the inflation outlook as
well.
Considering what might be behind the change in the indicators is particularly relevant, not least in
the current situation. You see, nominal yields on government bonds are up in the year to date. To
a large extent, though, that's due to inflation expectations, which are moving towards our target.
Higher yields on government bonds, then, are also a sign that our monetary policy is working.
Furthermore, better economic prospects usually also go hand in hand with higher real interest
rates.
Financing conditions therefore always have to be assessed in combination with economic
developments. And it is indeed the case that financing conditions are still favourable, all things
considered.
Advances on the vaccination front mean that the economy in the euro area, too, is now probably
making its way out of the crisis. This has implications for the PEPP, because the programme is
clearly tied to the pandemic and must come to an end once the emergency situation has been
overcome - that has been a hugely important point for me ever since the PEPP was introduced.
At that time, in March 2020, ECB President Christine Lagarde summed up the contingent nature
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of the programme when she tweeted: "Extraordinary times require extraordinary action". But
when is the emergency situation over as far as monetary policy is concerned?
Ultimately, it's up to the ECB Governing Council to answer that key question. I see two
preconditions for discontinuing net purchases under the PEPP altogether.
One is the expiry of all key measures introduced to contain the pandemic which restrict
economic life. That, you see, would be a sign that enough has been done to suppress the
pandemic or to overcome the health crisis. In addition, once the restrictions related to the
coronavirus have been lifted, they can also no longer exert downward pressure on prices.
The second precondition is an entrenched economic recovery. This is because the economy in
the euro area will then have to stay on course without the support of emergency monetary policy
measures.
This does not mean, of course, that monetary policy and fiscal policy will no longer support
economic and price developments, but the direct coronavirus-related measures should then be
rolled back in both policy areas. You see, the current projections indicate that economic output in
the euro area is already set to exceed its pre-crisis level in the first quarter of 2022. Furthermore,
the forecast suggests that the underutilisation of aggregate economic capacity in the euro area
will no longer be exceptional next year. That would no longer be a crisis year, in my opinion, if the
assumptions regarding the course of the pandemic and expectations about its economic impact
turn out to be substantially confirmed.
Owing to the uncertainty that still persists, we are unable to set a date for exiting monetary policy
crisis mode very far in advance. However, to avoid having to end the PEPP abruptly, net
purchases could be scaled back gradually beforehand. It will then become clear whether the
overall envelope for the PEPP ended up being used in full or not. In any case, it was right for the
ECB Governing Council not to commit itself either way on this score.
5 Conclusion
Ladies and gentlemen,
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According to Charles Rosenberg, "epidemics ordinarily end with a whimper, not a bang". The
incidence of the disease declines only gradually - an unspectacular yet inevitable sequence for a
last act. All the more reason, then, to talk about the conditions under which the emergency
situation can be considered over from the perspective of monetary policy. We should not wait for
a bang.
Thank you for your attention.
Rosenberg, C. E. (1989), What is an Epidemic? AIDS in Historical Perspective, Daedalus, Vol. 118, pp. 1-17.
2
Deutsche Bundesbank, Outlook for the German economy for 2021 to 2023, Monthly Report, June 2021.
3
Deutsche Bundesbank, Households' motivations for saving during the pandemic and their implications for the
projection, Monthly Report, June 2021.
4
European Central Bank, Eurosystem staff macroeconomic projections for the euro area, June 2021.
5
Author not named, Riesenschildkröte einer ausgestorben geglaubten Art entdeckt, Zeit Online, 27 May 2021,
www.zeit.de/wissen/umwelt/2021-05/riesenschildkroete-galapagos-inseln-artenschutz-ausgestorben
6
Borio, C. (2021), Is inflation dead or hibernating?, SUERF Policy Briefs, No 41.
7
German Council of Economic Experts (1976), Time to invest, annual report 1976-77.
8
Lagarde, C., tweet of 19 March 2020, twitter.com/Lagarde
9
Rosenberg, C. E. (1989), op. cit.