Wednesday October 27, 2021
The tale of the ECB critic
“Weidmann is a projection surface”
Prices are rising faster than they have been in decades. At the same time, the President of the Deutsche Bundesbank, who is widely regarded as a guarantor of stability, resigns. Is that the last dam against inflation? No, says central bank expert Florian Kern from the think tank department of the future. Contrary to what is often shown, Weidmann and the Bundesbank are behind the current course of the European Central Bank (ECB). The loose monetary policy is appropriate despite the recent price increases.
ntv.de: The announced resignation of Weidmann has raised concerns in Germany that the camp of “pigeons” in the ECB is no longer facing anyone who criticizes the loose monetary policy and has the inflation risks in mind. First of all: Does this image of opposing stability advocates like Weidmann on the one hand and supporters of a loose monetary policy on the other correspond to the reality within the Governing Council?
Florian Kern: From a human point of view, it is understandable that it is presented this way. Confronting camps and conflicts are particularly exciting for the media. But in fact the image of doves and hawks does not apply to monetary policy at the moment. These terms are about the dispute about how monetary policy should react when there is too much inflation. Should it raise interest rates quickly in order to fight inflation as early as possible, but accept losses in growth and jobs? That is traditionally the position of the hawks. Or should it, as the pigeons advocate, proceed more cautiously and accept slightly higher inflation? But we don’t have this situation and this conflict at all. All central banks within the Eurosystem agree that an accommodative monetary policy, i.e. one that supports the economy, is currently appropriate – including the Bundesbank. There are only differences of opinion on details, such as whether a bond purchase program should run a few months longer or shorter, or which bonds should be eligible for it.
One often hears about Weidmann that he stands for a completely different direction of monetary policy, but that he was unable to assert himself in the ECB. What impact will his departure have?
The Bundesbank never has to assume sole responsibility for decisions in the Eurosystem. In recent years the role of a warner and admonisher has tended to be taken on. If the Bundesbank had to decide on its own, it would most likely have followed the same monetary policy direction. Even if the Bundesbank were to watch over Germany’s currency alone, we would have negative interest rates. A look beyond the euro area shows that. All major central banks in the region operate similar policies. Simply because it is currently necessary. I expect that whoever will follow Weidmann will continue to be critical of politics. What I would like is that he or she can convey the positive, the basic consensus in the Governing Council more clearly in the future.
Was it a mistake on Weidmann’s part to focus communication on the differences and this warning?
I’m not sure if he even set this focus like that himself. Weidmann has become a projection screen for fear of inflation in Germany. His last newspaper interview in August is an example of this. The first four questions are templates to get something critical from him about the level of key interest rates, bond purchases and the ECB’s assessment of inflation. Weidmann blocks four times and explains why interest rates are low and the bond purchases are necessary and that the ECB is by no means wrongly assessing the risk of inflation. Nevertheless, the journalists put a heading like “Weidmann warns” over the interview. However, I would have liked it if Weidmann had, in recent years, more clearly opposed the accusation, which has been repeatedly expressed, especially in Germany, that there are people on the ECB Council who maliciously violate their legal mandate to finance the budget of unscrupulous finance ministers .
Weidmann has actually emphasized several times recently that it is necessary to keep an eye on the risk of inflation. Shouldn’t we worry if this warning voice is missing from the ECB?
Everyone in the ECB is aware of the risk that inflation could pick up again in the future. However, this means something different from the currently observed inflation, which is mainly due to delivery bottlenecks and rising energy prices. Monetary policy cannot do anything about this. The ECB could do something if wages galloped off across the board. However, this cannot currently be assumed, as is the case, among other things, from Weidmann’s statements or the Monthly report of the Bundesbank from August 2021.
Why can’t the ECB do anything about the rising prices, isn’t that its mandate?
Of course you have to react to rising energy prices. But this is a case for politics, which can make rising prices more tolerable with tax cuts or transfers, and not for the central bank. When a doctor treats pneumonia, it doesn’t just matter how severe the disease is, but whether it is caused by bacteria or viruses. An antibiotic cannot do anything against viruses and, in case of doubt, can even do harm. For example, higher interest rates would not lower the prices for gas and oil imports, nor would it ensure that more ships and containers are available for sea transport so that the supply chains function smoothly again.
Isn’t there a risk that the current price increases owed to external factors will trigger the much-cited wage-price spiral and inflation get out of control?
That would be the case if the expectation is established that these price increases will go on and on. That is not to be expected, because why should the higher freight rates due to the current chaos in shipping or the energy prices rise again next year? On the contrary, it is to be expected that they will decline significantly again. Therefore, it is initially the task of the ECB and the Bundesbank to explain this and to influence inflation expectations with rational arguments. This economic educational mandate can be derived directly from the mandate of the Bundesbank. Only if the central banks fail in this task and, contrary to all common sense, a wage-price spiral is expected following a supply shock, would the Eurosystem have to react with interest rate increases. But that would be an emergency solution and certainly not the best option.
There is widespread concern that the ECB will no longer be able to react in this case because the loose monetary policy of recent years has maneuvered itself into a dead end. Wouldn’t some highly indebted EU countries like Italy actually face the financial abyss if interest rates rose due to a change in monetary policy?
I do not consider the assumption that the ECB will be able to raise interest rates because of the bond purchases to be convincing. In the US, the Fed did it once before in 2015 and 2018, why shouldn’t we be able to do the same in Europe? Interest rate hikes would lead to a loss of market value on central bank balance sheets, but the Bundesbank has done that before. It even had negative equity once in the 1970s, but therefore did not pursue a monetary policy that was too loose. The fact that interest rates cannot rise because countries like Italy would then face the abyss is not true because Italy has financed its national debt over the long term. In addition, the national debt in the euro area is lower overall than in the USA, Great Britain or Japan, for example. Italy can therefore cope well with a rise in interest rates, which usually happens in an environment of stronger nominal growth. Above all, however, the central banks in the Eurosystem have a clear mandate, namely price stability, and are also the most independent central banks in the world: Why should the decision-makers in the central banks act illegally with a monetary policy that is too loose and thus take responsibility for the mistakes of the finance ministers? I’m really not worried about that.
Max Borowski spoke to Florian Kern