TRANSCRIPT: Interview with ECB Governing Council member Šimkus on 27 July 2021

28 July 2021

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on July 27 with Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania and member of the Governing Council of the European Central Bank:


Q: Governor, how much of a change does the latest decision represent?


A: Let me begin by saying that reaching an agreement between 25 different people is already a challenge. Reaching an agreement between 25 different economists is even harder. What we can be really proud of and what gives us a lot of credibility is the unanimous agreement reached on the monetary policy strategy review. This same spirit prevailed at this monetary policy meeting, where we discussed forward guidance. Each of us on the Governing Council has his own line of thinking, but again, the agreement achieved was by overwhelming majority, and this gives a lot of credibility to the forward guidance. That is crucial, because this guidance is the main indication of our monetary policy intentions based on the assessment of the economy and should therefore give people a clear message about where we’re going. The formulation that we will keep interest rates at their present level or lower until we see inflation reaching 2% well ahead of the projection horizon and, what’s very important, for the rest of the projection horizon, gives us a lot of credibility that our monetary policy will be patient and persistent, and will not over-react to temporary factors. So, to the question you were going to ask about whether I see a risk of the ECB falling behind the curve and needing to correct course sharply, the answer is no. I think in particular the possibility to overshoot the symmetrical inflation target of 2% temporarily and moderately is a very important and credible confirmation of our understanding that we need to act patiently, timely and then bravely. With the overall aim to have inflation at 2% over the medium term.


Our monetary policy is guided of course by the objective of price stability. And here what needs to be mentioned is that whether we look at inflation projections produced by the Eurosystem, based on financial markets or based on surveys, they all point to inflation levels at the end of 2023 well below target. So, we should remain patient, we should remain persistent in order to have inflation converging to the target. We shouldn’t over-react. I understand that some people may think that we may get behind the curve, but our new and clearly symmetric inflation target, with negative and positive deviations from the target equally undesirable and with the possibility to overshoot, even if on a transitory and moderate basis, will actually help us avoid sharp corrections.


Q: What’s your personal view of the 2023 headline inflation projection of 1.4% and the risks?


A: The inflation outlook has improved, but various sources of information all confirm that over the medium term, headline inflation falls below our target. I understand that there are many temporary, short-term factors affecting inflation, but what really matters for the medium to long term is how wages evolve. And in the euro area, we still have quite high unemployment and wages are not growing fast. Therefore, even if we see a pick-up in inflation this year, my view is that it’s transitory and inflation will fall back below 2%. Regarding the projections, they are made on the basis of the information available at the time of the projection exercise. I know that the Eurosystem staff is doing their best to ensure as accurate projections as possible. What we shouldn’t forget is that projections are subject to uncertainty and error, so although typically presented as a point value, they could be viewed as actually distributions of points with different probabilities. In the current environment of high uncertainty, even with the containment measures being lifted in most euro area countries and with the economic rebound from the second quarter, there are doubts. We have now this delta variant, which on the one hand seems quite contagious and on the other doesn’t seem that harmful. So we have fewer hospitalizations and fewer deaths. But this is only delta. What I’m not sure about is whether we’re going to have another Greek letter variant later this year. That’s one thing. Another thing, judging from the experience of Lithuania, is that we have an increasing number of vaccinated people - which makes us more optimistic about our resistance to the virus - but we are also seeing a decreasing pace of vaccinations. Some countries have achieved herd immunity, but in other countries the pace is decelerating. So the question becomes: what measures will be taken by governments if the delta or another variant spreads. This brings a lot of uncertainty. And another issue is the disruption of supply chains that we see at the moment. So even if we have economic growth, uncertainty remains elevated. And I’m saying all this because the Eurosystem staff does their best to project growth and inflation in this environment of uncertainty. I think it’s quite natural that we revise the projections. What’s important is that we understand that uncertainty is high and that the distribution of potential outcomes starts out wide and then shrinks over time.


Q: Do you share the view expressed in the last meeting account that the inflation in other advanced economies further along in the recovery ‘could be a harbinger of developments in the euro area further down the road’?


A: No, because there are differences about the euro area that will persist. Unemployment is very high here, and this affects wage growth, which is what really matters for inflation in the longer term. And so we see far slower wage growth in this region than in other advanced economies, even if in some countries of the euro area, like Lithuania, wage growth is pretty fast. But that’s very much related to economic convergence. Possible differences in fiscal policies going forward also matter, and yet another factor is that inflation expectations are still below target here, which is different from the situation in the US. So we can’t compare two regions like the euro area and the US and directly translate developments there to here. We can draw insights, but we should not take parallel developments for granted.


Q: According to the June ECB Survey of Monetary Analysts, median expectations called for the deposit facility rate to be increased in May 2024. How should the new strategy and the guidance based on it affect their understanding of the ECB’s reaction function?


A: Even before the change in the strategy, I did not think that these expectations were in line with our monetary policy reaction function. The Survey of Monetary Analysts in June showed that the median expectation of HICP in the second quarter of 2024 was 1.7%. This is the quarter when the expectations were for an increase in the deposit facility rate. Median long-term inflation expectations stand at 1.8%. Our monetary policy strategy review resulted in a new, symmetric inflation target of 2% over the medium term, with a conditional commitment to take into account the implications of the effective lower bound. At the latest monetary policy meeting, the adjusted forward guidance on interest rates incorporated these changes. We intend to keep key ECB interest rates at their present or even lower levels until we see inflation reaching 2% well ahead of the end of our projection horizon. From all this, it’s quite evident that these expectations are not in line with our monetary policy reaction function, and I think the new formulation of our forward guidance will help markets better understand that our monetary policy will be patient and persistent in order to eventually converge to 2% inflation over the medium term.


Q: Then the next Survey of Monetary Analysts should confirm this.


A: That’s a good point. Let’s see.


Q: To what extent do you think that the medium-term HICP staff forecast might be motivated by a desire to justify keeping policy accommodative as long as possible?


A: I’m sure that the Eurosystem staff projections are absolutely objective and based on their understanding of the economy and the information that is available at the time of the exercise. So the idea that the outcome could be politically motivated or be intended to help peripheral countries by keeping interest rates low is purely speculative. It’s an objective process that involves all euro area countries and many highly professional people. And referring to the impact of an interest rate hike on debt, it’s not so straightforward. First of all, it will take some time before we get to that, as the forward guidance suggests. Having said this, even if interest rates do rise at some point in the future, it will translate into higher debt costs only gradually. Only newly issued debt will be subject to the higher interest rates.


Q: And yet many Governing Council and especially Executive Board members were very negative about the economic outlook until recently, not even wanting to say ‘upside risks’ even as a strong rebound became apparent. Every favourable comment by President Lagarde about economic developments is still immediately followed by ‘but’.


A: It’s very typical of economists. We’re trained to talk like this – ‘on the one hand, but on the other hand.’ I find the risk picture of the monetary policy statement quite balanced, with the references to both upside risks and downside risks. And I agree with the assessment of broadly balanced risks to medium-term growth. We have very high uncertainty. The virus is something that we don’t control. This is like exogenous uncertainty which is unpredictable. And now we have the delta variant, on which vaccination may work differently. I really think that until we beat the virus, or at least know how to live with it, there will always be some doubts and risks that need to be stressed.


Q: At least in France, the central bank does not see the Delta variant to be as great a risk as the difficulty of finding qualified labour or supply constraints.


A: I can talk here about Lithuania as the country I know best, and the situation is completely different. We suffered relatively little in terms of the economy, which contracted last year by less than 1%. We already got back to pre-pandemic output levels in the first quarter of this year. We are talking about closing the output gap and worried about economic overheating. The point is that the euro area economies are very heterogeneous, so each country faces its own issues.


Q: For Lithuania the crisis phase seems to be over; when is it going to be over at the level of the euro area, and do we have a good way to define it?


A: It’s a very important question, because it relates closely to the PEPP, which is specifically designed for the emergency. This is something we need to work on in the Governing Council, probably this year, because the Council will terminate net asset purchases under the PEPP only once it judges that the coronavirus crisis phase is over, but in any case not before the end of March 2022. So we obviously need to have some clarity on how this crisis phase is defined, because March is a sort of deadline by which we need to have a clearer picture. This is something that the Governing Council needs to define.


Q: What do you think should happen?


A: At this point in time, it’s still a bit premature to talk about this. We will certainly discuss asset purchases in the Governing Council later this year when we debate about the PEPP. The emergency aspect is part of this, along with the implications for our policy stance and the need to avoid potential cliff effects. But most importantly, in all these discussions, we should make sure that inflation robustly converges eventually toward our 2% target, and premature tightening should be avoided.


Q: Are you suggesting that PEPP might need to be extended, since there’s little likelihood of any robust convergence within a very few months?


A: No. I’m just saying that we need to discuss this later on. What happens to PEPP then very much depends on the outlook at the time of the assessment and on the epidemiological situation. So we’ll see later this year.


Q: Still, do you lean in one direction or the other?


A: It’s really a bit premature yet. I think we need to decide on this on the basis of all the information that is available at the appropriate time to make a decision.


Q: If the APP doesn’t become more flexible when the PEPP ends, what will allow the ECB to respond to market fragmentation that threatens transmission?


A: That’s a very good question. With its inherent flexibility, PEPP has been very successful in reducing fragmentation in the euro area. But once the risk of fragmentation is no longer a matter of concern, why do we need to transfer the specific feature of flexibility into other asset purchase programmes that have different purposes? So, yes, flexibility was an important factor in the PEPP’s success, but this does not automatically mean that we should transfer this characteristic to another asset purchase programme. And here I would repeat that we’ll have to see whether we need a measure with such flexibility beyond March 2022, because we’re going to have it at least until then anyway. So we’ll see, and we’ll make a decision on the basis of the information and the situation at the moment of the decision.


Q: But fragmentation could occur quickly.


A: That’s absolutely right, and I agree, and what’s really very important is that if fragmentation occurred, the Eurosystem can act very forcefully with a targeted measure. We proved this in 2012 with OMT and we deployed the PEPP when it was needed in 2020. So here I think what’s important is that the Eurosystem is ready and can act forcefully to address fragmentation when it’s needed to ensure the transmission of monetary policy.


Q: So even if we don’t have an existing programme with the flexibility of the PEPP, we’re in a position to quickly create an appropriate instrument if needed.


A: I’m not thinking that we will need to have a new instrument with this kind of flexibility. I wouldn’t strongly insist on this. We already have the experience of having this kind of instrument. It’s something that needs to be discussed and elaborated later on, but for me, it’s very important that the Eurosystem proved that it can act with those kind of measures, and this experience is already reassuring.


Q: Can you say anything about how forward guidance will need to change in September with respect to asset purchases?


A: It’s very important to note that now we decided on the forward guidance only about interest rates. In September, once we analyse the asset purchase programme and consider decisions, if needed we will review the forward guidance on those programmes.


Q: What if 2024 comes and despite everything, we still haven’t achieved price stability?


A: If we are still not getting to 2%, then we are doing something wrong and need to think how we can strengthen our toolkit or change something. Otherwise, we are not delivering, basically.


Q: But there are well known reasons for low inflation and the euro area isn’t the only area with a lowflation problem.


A: Yes, but what’s important is that we have inflation as a target. When you have full employment and inflation of 1.8%, that’s one thing. But then you have high unemployment and you don’t get to your 2% target. Then probably you should think about what you can do and how you can put more fuel on the fire. A moderate level of inflation also fuels economic activity.


Q: How comfortable are you with overshooting and how do you understand ‘a transitory period in which inflation is moderately above target’?


A: Moderate and transitory overshooting is an important part of our decision in favour of a new, symmetric 2% target over the medium term, and this is clearly reflected in our new forward guidance. It also expresses the idea that monetary policy will be patient. How do I understand ‘moderately’ and ‘transitory’? We don’t have specific numbers behind these terms. Probably this is something to be seen once it becomes an issue. It’s not about the number at a given moment; it’s about the intention.


The formulation that we will keep interest rates at their present level or lower until we see inflation reaching 2% well ahead of the projection horizon and, what’s very important, for the rest of the projection horizon, gives us a lot of credibility that our monetary policy will be patient and persistent, and will not over-react to temporary factors. So, to the question you were going to ask about whether I see a risk of the ECB falling behind the curve and needing to correct course sharply, the answer is no. I think in particular the possibility to overshoot the symmetrical inflation target of 2% temporarily and moderately is a very important and credible confirmation of our understanding that we need to act patiently, timely and then bravely.