Interview with CNBC

Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Annette Weisbach, CNBC, on 12 November and aired on 13 November

17 November 2020

Thank you for talking to us tonight. The virtual Sintra conference is over. What are your main takeaways from the conference?

It’s a pleasure to be talking to you today. The ECB Forum is always our big annual event, and we discussed all the big topics that are on the table. Of course, this year the ECB Forum was very much dominated by the pandemic on the one hand and long-term structural trends on the other. And both of those are playing a very important role in our ongoing monetary policy strategy review. So, in a sense, the ECB Forum is also part of our listening events, because we had all these interesting people presenting their papers and participating in panels. And one of the important messages is that life has become more complicated for economic policy, including monetary policy and fiscal policy. It seems that we can only do it together. There is a need to act in a complementary fashion. I think that this is actually a very important message.

What do you mean by “life is actually getting more complicated”? Perhaps you have some examples?

From the central banking perspective, the biggest issue is the long-term decline in the natural real interest rate, which poses challenges. And these challenges already appeared years ago because interest rates were approaching the zero lower bound, which is now called the effective lower bound. This makes it difficult for central banks because they can no longer use conventional monetary policy tools and have to use unconventional monetary policy tools instead. But, as I said in the panel I was chairing today, the unconventional tools have become quite conventional by now.

You have been talking about the possibility of cutting rates further into negative territory. Is that a policy option that is also realistic for December?

We have always said that we are going to look at all the instruments. President Lagarde also made that clear in the press conference. But there are reasons why we haven’t reduced interest rates in the past and now we have to check whether these reasons are still valid.

What are the reasons for not dragging them lower? Perhaps that might make the market understand what you are looking at exactly.

One important argument is the effects that low rates may have on the banking sector. We have been thinking about this quite a lot and we introduced new measures to help counteract these effects, such as the tiering multiplier, which is quite important and has been quite successful. All of our monetary policy decisions always involve a cost-benefit analysis. We have to look at the effectiveness of the measures in the current circumstances and we have to think about the side effects, and we will always choose those instruments for which this balance is the best.

President Lagarde has narrowed down the focus on increases to the pandemic emergency purchase programme (PEPP) and potential new targeted longer-term refinancing operations (TLTROs), or a recalibration of the current TLTROs. How likely do you think it is that we will get an extension of the whole programme, because clearly that would also be a big signal?

What the Governing Council said is that, in the December meeting, we will recalibrate our instruments, as appropriate, in order to preserve favourable financing conditions and counteract the impact of the pandemic on our inflation outlook. What the President added in her Sintra speech is that – and this is an important point – it’s not only about the level of financing conditions but also the duration. The important message is that the ECB is going to be there for as long as necessary. And what that means depends very much on the evolution of the pandemic and on the speed of the roll-out of the vaccine. All of this is very important. Given that all these measures may be with us for quite some time, we also know that potential side effects may get bigger over time. Therefore, I think we also have to discuss the intensity of our asset purchases, which is also important. So we have to ask: what is the intensity of purchases that is needed to preserve historically low financial conditions?

By intensity do you mean the monthly pace of purchases?

Exactly.

So, would you rather say we need to be very flexible when it comes to that? So, for example, if we see fragmentation increasing, if we see the economy deteriorating, that you can increase it very flexibly?

Yes, flexibility is certainly key. We saw in March that the flexibility was extremely important to deal with that situation of market turbulence. Of course, we are now in a very different situation than in March, because financing conditions are extremely benign and we do not face any market turbulence. And this is also why I think we cannot just do the same all over again, but we have to rethink what is the best and most efficient way to act in order to achieve our objectives. There is broad agreement that what is key is that financial conditions remain at this favourable level. And the question is: how can this best be ensured? Let me add that monetary policy will not be able to do it alone; we also rely on fiscal policy, which has to remain active for as long as needed. Monetary policy and fiscal policy have acted in a very complementary way in the past month and I think this should continue. So, both monetary policy and fiscal policy must not be withdrawn too early. And especially at this current time of very high uncertainty, the fiscal side is important, because the private sector may be reluctant to spend, that is consumers may be reluctant to consume and firms may be reluctant to invest. This is why public expenditure is very important, which may then also spill over to private spending.

Are you also supporting banks and the financial sector to be able to lend enough to the real economy, given the enormous pressure they are under as well as the risk of non-performing loans? So in other words, are you looking at TLTROs and potential changes in the tiering?

Let me first stress that, given that the euro area is a bank-based economy, the bank lending channel is absolutely crucial for us. And we have to make sure that this bank lending channel remains operational. In the first months of the pandemic, I think the TLTROs played a very beneficial role. The most important feature of the TLTROs is that they are targeted, which means that there is an incentive to fulfil a certain lending threshold. And I think this principle is important. I also think this will have to play an important role in the new measures, so that there is an incentive for banks to continue lending, because we are a bit worried about that. In the recent bank lending surveys, we have seen that some banks expect a tightening in credit standards. Of course, we have also seen a drop in demand for loans. These are very challenging times. And so it’s important that lending remains as strong as needed in order to get out of this pandemic and to support the recovery.

This week we also saw substantial news on the vaccine front. So do you think that is actually a game changer for the economic recovery?

This is, of course, excellent news. And I think everybody was very relieved. If we look at the economic developments, what we’ve seen is that there was this very strong rebound, stronger than expected in the third quarter. This is good news because it shows that, once restrictions are lifted, there is actually the potential to recover quickly. But then we also saw the rise in infections. And this has led to new lockdowns, which have substantially dampened the outlook for the fourth quarter, and also for the first quarter of next year. So our outlook has become more pessimistic. I think the positive news on the vaccine now basically puts us back in our baseline scenario, because the baseline scenario that we formulated in the middle of the year foresees a vaccine being rolled out in 2021. So this is not a game changer in that sense. But it kind of leads to a slight improvement compared with how things were before that news.

If you look at the economic recovery, clearly the recession, or the potential recession, is more or less led by the services sector. Are you thinking that will also have an effect on the strength of the recovery? Because there’s not so much pent-up demand?

Yes, exactly. This was also one of the major points in President Lagarde’s speech, that this services recession may be very different from a regular recession. So one question is: how long will the recovery take? And another is: what are the effects on employment? So far, we’ve seen that the unemployment rate has not gone up that strongly, which is mostly due to the public support programmes, especially the job retention schemes. It’s also due to the fact that some people have actually just stopped looking for work altogether, and they do not count as unemployed. Christine Lagarde called them “discouraged” workers. So this recession is certainly different from others. What we also see, which I think is important, is that it hits different countries very differently. And it also hits different people within countries very differently. This actually raises new challenges, mostly on the fiscal side. But, of course, it also affects monetary policy.

You’re hinting at the effect that social equality is actually getting a lot worse because the pandemic is hitting those who anyway don’t earn much a lot harder than those who are rich, right?

Yes, we’re basically seeing the same thing at the country level and at the individual level – that the weakest are hit the hardest. And one really has to think carefully about how to deal with that. So why does that matter for monetary policy? It matters because the effects of monetary policy, just like fiscal policy, also depend on people’s propensity to consume. Those who are poorer typically spend a larger share of their income and therefore the composition of the population actually does have an effect on the transmission of monetary policy.

And let’s look at what it also means going forward for Europe versus the United States, because the bond markets, interestingly, are behaving as if the United States will recover a lot faster than Europe, because yields are picking up there once again. Do you think that’s fair on Europe?

Well, that remains to be seen. One advantage that the United States has is that, overall, its economy is a bit more flexible. So maybe some people expect that the United States will be able to adjust more quickly, also to the new world that we are going to face, because I think what is clear is that after the pandemic, the economy will look different from what we have now. So there will be structural changes. And it could be that the United States is better able to adjust to this new world. Apart from that, of course, many things in the United States will depend on fiscal policy. It is not yet clear whether there will be a big stimulus package or not, but for the United States, that will be very important.

But the President-elect Joe Biden has promised to deliver on that front; everything depends on whether the Democrats can also get a majority in the Senate.

Exactly. That’s a crucial point. And if not, I think the fiscal response will be weaker.

Today, I was speaking to the Siemens CEO, Joe Kaeser, who was very much pleased by China, and was saying that China will once again be dragging the world economy out of the situation it is in. Do you think we really depend on China when it comes to our economic recovery story?

Well, China has become a big player in world trade. So if China has a good recovery – and this is what we are seeing – this has a positive impact on world trade and all those companies that rely on exports benefit from that. I think it is actually good news that we are getting positive effects from the global side.

Falling natural rates and, at the same time, higher volatility and asset prices pose a problem for the formulation of monetary policy. So what does it mean exactly for the future of monetary policy, and also the level of rates?

What we’ve seen is that, due to the decline in the natural rate of interest, we’re more likely to hit the zero lower bound. And this constitutes a constraint for monetary policy. One important question in our monetary policy strategy review is what this actually implies for the inflation objective. So there are people who are proposing to raise the inflation target, but of course, there you get an issue of credibility, because if you haven’t been able to hit 2%, will you be able to hit 3%? That is not so clear. Then there are people who propose that one should follow a strategy like that of the US Federal Reserve. So, something like average inflation targeting, which works through an expectations channel. It relies very much on agents having forward-looking expectations and being rational. And again, it is far from clear whether these conditions are fulfilled. Then there are others who are a bit more modest and who say that we should have a clear commitment to symmetry. And actually, symmetry is already always in our introductory statement, so this would be an easy thing to do.

But you’ve not yet decided within the Governing Council on which is the best way to formulate an inflation target, right?

No, we haven’t come to a decision yet. And we are, of course, working on these topics intensively. We have regular meetings of the Executive Board, and especially of the Governing Council, in order to discuss all the background notes and analyses that are being produced. This is a big project that covers many important topics, and the whole strategy review will only be finished in the second half of next year.

Let’s talk a bit as well about the effectiveness of fiscal policy. It seems, according to the research papers which were also presented during the conference, that it works best at the lower bound, or rather the zero lower bound. Is that true? And why is that?

Well, there’s an easy explanation for that. You would normally say that when fiscal policy is very active it leads to a crowding-out effect because overall rates in the economy may increase. But if we are at the zero lower bound and can be sure that monetary policy remains active, that means that this crowding-out effect is not kicking in.