Peter Praet: Interview in Financial Times
Interview with Mr Peter Praet, Member of the Executive Board of the European Central Bank,
in Financial Times, conducted by Ms Claire Jones and published on 12 December 2013.
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The European Central Bank has forecast inflation of 1.3 per cent in 2015, which is
usually seen as the policy-relevant horizon. How can you justify not doing more now
when inflation is forecast to be almost a third below your target two years from now?
We aim at an inflation rate of close but below 2% over the medium term. Given the subdued
outlook for prices, we are already doing a lot. We have cut rates. Since July 2012 our
overnight rate has been in general lower than that controlled by any other major central bank.
We have offered our forward guidance. We have extended the conduct of our main
refinancing operations as fixed rate tender procedures full allotment until at least 7 July 2015.
So, after a prolonged period of low inflation, we would expect inflation rates to return back to
rates closer to 2%. However, this will take some time given the nature of the shock, namely
the unwinding of real and financial imbalances, and the possibly longer than normal
transmission lag of monetary policy in such an environment.
But we have also said that we are ready to act again should risks to the downside
materialise.
What matters, in particular, is that medium to long term inflation expectations remain firmly
anchored in line with price stability.
Mr Draghi said last Thursday that there had been a brief discussion of negative
interest rates and that any further LTRO would have to involve an extension of lending
to the real economy. Are these two policies for which you feel as though you could
build a strong consensus of support on the governing council should economic - or
financial - conditions disappoint?
What is important here is to remember that the governing council unanimously - and I'd like
to emphasise this - shares the same assessment of economic conditions. There is unanimity
on the outlook; the view on the economy is very much shared in the governing council. Price
pressures are going to be subdued for a prolonged period of time
As a result, we all agree to have an accommodative monetary policy for as long as needed.
And even take more measures, if needed.
That's why we can say: we are ready to act and able to act.
Under what conditions would you act?
We are very well aware that price pressures are likely to remain subdued for a prolonged
period of time but we expect inflation rates to converge again towards 2 per cent as the
cyclical upswing of the economy takes hold.
We are at the same time very conscious that, if some of the downside risks do materialise,
then - because price pressures are already weak today - we would act decisively again.
This view is very strongly shared by the governing council members.
What are the scenarios that could lead you to act?
There are a number of downside risks that we have identified.
They relate to the state of the economy and downside risks to growth, a tightening of global
financial conditions with undue spill-overs to the euro area, energy prices, and - last but not
least - a fatigue in structural reforms in Europe. This would mean that investments do not
pick up and that business confidence doesn't improve further. For me that's the most
important aspect of all - that structural reforms are being implemented so as to improve
growth potential, employment opportunities and overall confidence. However, for this last
downside risk, monetary policy has clearly its limits in what it can do.
Another risk would be that, as a result of the comprehensive assessment, there could be
some dampening effect in the short term. That risk is still fairly limited and temporary - and
should be compensated for by the expansionary effects over the medium term, which will
positively affect confidence in the nearer term. We will be monitoring this risk from a
monetary perspective.
However, this potential procyclical effect of an AQR should not lead to softening the rules of
the AQR.
The instruments you use to handle each scenario may depend of the nature of the shock.
Each instrument has a different impact and any of the measures taken would depend on our
analysis of the monetary and economic developments.
Could you just say a little bit more about the possible impact of the AQR?
A strong comprehensive assessment makes central bank action more effective. Monetary
policy does not work as well if banks' capital basis is thin and insufficient to support lending.
In the US, you can intervene directly in the markets to transmit monetary policy stimulus,
because the markets play a bigger role in financing the economy. Here, the pass-through of
your monetary policy is primarily via the banks and it takes time. The comprehensive
assessment should shorten the time it takes for monetary policy to impact the real economy.
Indeed, it is easier for the central bank to support the economy as healthier banks tend to
lend more.
The worst case, to say it very bluntly, is of a central bank providing liquidity to banks just to
buy or carry legacy assets, and the banking sector doesn't restructure. This was typically the
Japanese situation in the early 2000s.
Perhaps paradoxically, a rigorous AQR and stress test helps monetary policy. Appropriately
treating banks' holdings of sovereign debt according to the risk that they pose to banks'
capital makes it unlikely that the banks will use central bank liquidity to excessively increase
their exposure to sovereign debt. This is because banks will be wary of the constraints
placed on sovereign debt by the stress tests to which they are subject at the same time.
Therefore, should the procyclical impact of the AQR be significant, then monetary policy
would be able to act - without hesitation and being reassured that the side effects of a
liquidity injection that we have seen for the 2011-2012 operations would be minimised.
So how would you assess whether the AQR was procyclical?
Don't forget we have our two pillar approach: we analyse the business cycle, but we also
look at money and credit.
We will see from the second pillar very quickly if the credit situation doesn't improve. At this
stage of the recovery, what we see at the moment is quite normal. The big corporate firms do
not have as many constraints as the SMEs. They have around €2trn in excess cash, they
can access debt markets. The reluctance to invest comes more from the business
confidence side.
And if you did act because of the impact of the AQR, what exactly would you do?
Depending on the situation, the central bank can decide on the most effective way liquidity
provision can be provided.
There are no restrictions on the way a central bank provides liquidity to the banks via repo, a
priori.
You want to reach your price stability objective. At the same time, you want to be sure that
when you provide liquidity against adequate collateral, it doesn't reduce the incentive to
restructure the banking sector. And so by having a well-designed comprehensive
assessment - like the one we're preparing now - we are easing the job of the central bank.