TRANSCRIPT: Interview with ECB Governing Council member Kazāks on 28 July 2021

29 July 2021

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on July 28 with Mārtiņš Kazāks, Governor of Latvijas Banka and member of the Governing Council of the European Central Bank:

Q: Governor, how much of a change does last Thursday’s decision represent?

A: A very important point to make is that the new strategy was supported unanimously, so both the spirit behind it but also the wording. The strategy is of course a framework. It does not provide a blueprint for how to react each and every time. It’s state-dependent and case-specific. And at last Thursday’s monetary policy meeting, we adjusted the forward guidance for interest rates. This time we did only the rates; that’s important to stress. As to what’s different, one thing is that we now refer to a symmetric 2%. Another thing is that it’s much more precise in terms of how we approach the subject of the robustness or sustainability of inflation. There is both a forward-looking element, which is the forecast, and of course an outcome-based element as well, which is what the data say, for example with respect to underlying inflation. So our decision provides more clarity versus what we have had so far. At the same time, of course, how we act is going to be state-dependent, dependent on economic and inflation projections as well as underlying inflation developments. So we will act as we see appropriate at each moment. We’ve provided more clarity, but without tying our hands.

Q: And ‘well ahead’ is an example of this.

A: Yes. We can react somewhat differently if it’s a demand shock or a supply shock. If we take a look at the current situation, we’re coming from below 2% for the euro area as a whole. Inflation expectations have improved, but are still well below 2%. When we look at other measures of inflation, we also don’t see them indicating inflation robustly and sustainably at 2%. The current pickup in headline HICP is due to temporary factors, though some of them may last somewhat longer than we expected. For example, supply bottlenecks seem to be dragging on for longer than initially expected. But still, the major factors are transitory, so we expect inflation to calm down next year. And what this forward guidance story is telling is that it is not sufficient in terms of our forecast if we see inflation at 2% at the end of the forecast horizon, or even somewhat above 2%. Because the further you look, the greater the forecast errors. So we wanted to reduce the room for error, and that is what President Lagarde meant by midpoint – not now, but also not at the end of the forecast horizon. It’s in-between. So your forecast errors become smaller and you’re much more certain about the inflationary dynamics going forward.

Q: How much danger do you see of the ECB’s monetary policy getting behind the curve, forcing an unnecessarily sharp correction at some point?

A: My answer is no. Implicitly of course, there is a risk of that, because it’s always possible for the economy to surprise. But if anything, what we have learned from the past is that we should not make the mistake of premature tightening. Of course, we are careful. But when we see that the economy is stronger and the recovery is robust, then we will act accordingly. So, I don’t think we should be thinking that the ECB is falling behind the curve. No. We are not behind the curve, but if the economy surprises to the upside, then we will move more quickly than we currently envisage.

Q: The point was made at the June Council meeting that repeated upward forecast revisions stood in contrast to the previous assessment of downside risks.

A: Speaking just of myself, I by and large agree with the assessment of the balance of risks. In the spring, my view was that inflation and the economy could surprise us to the upside. But I was still happy with the forecast. We are taking into account the risks to the economy as new information comes in. Uncertainty has been very high and we have seen inflation surprise us on the downside in the past. The current labour market still shows a quite significant amount of slack and we don’t see the strong wage pressures that it would take to make current inflation more persistent. So the economy still needs some time to recover. By and large, I think the Council has been very correct in its assessment and the balance of risks.

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: Without commenting on specific dates, one thing that I would point out is that markets were expecting that we would start lift-off at inflation levels way below 2%. I think their understanding was misleading in this respect. With the inflation target now at 2% and symmetric, we would not be that willing to move with inflation rates so far below 2%. And our new forward guidance very clearly says this. The major problem was markets’ misunderstanding in terms of our lift-off inflation level.

Q: How valid do you think current staff projections for growth and inflation remain?

A: At the current moment, I think we are still broadly within the forecast range. There is significant upside here and there, and the economy overall may bounce back more strongly than we expected. But there is still the downside, and of course the best example of that is the Delta variant. We don’t know what’s going to come out of that. So we have to be cautious, and this cautiousness will also guide our policy decisions.

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: It varies from economy to economy. It can also be that supply is constrained by health restrictions, and when the restrictions are lifted, supply increases. But supply bottlenecks are another important risk to growth. If these things don’t get resolved, they will slow down the recovery. As to the balance of risks, the situation now is much better than for instance last autumn, when there were plenty of downside risks and you had to look very hard to find upside risks. I think now the situation is much more balanced, and I very much agree with the balanced risk assessment. So far the June forecast is pretty much in line with what’s happened. If we take a look at the inflation forecast, then I would say that I would be somewhat more optimistic towards the end of the forecast horizon. What has been done in terms of the strategy update (to reduce perceived asymmetry from the “close but below”) and forward guidance (explaining rate lift-off), as well as of fiscal developments in the US, can make me more optimistic.

Q: You said back in May that ‘if the inflation outlook remains like the current forecast when PEPP ends, I think we would certainly discuss increasing APP’. Do you still see the need to discuss this?

A: We will discuss it. I think at the current moment, it’s still premature to talk about phasing out the PEPP. We have the programme as it is until at least next March, with the size of the envelope known as well, and we have flexibility. If we see that we need to support the economy more, we may increase the size or the time frame, and vice versa as well. I think currently it’s still premature, but when we get closer to this date, then we will consider what support the economy needs, what instruments are better used, and how we should change – if necessary – the instruments already deployed. It is going to be discussed, but at the moment there’s no need to do so. It’s still premature.

Q: When should we expect this discussion? We’ve been talking about talking about it for a while.

A: At the current moment, uncertainty is still too high. Of course, we will not surprise the markets in March by saying, “That’s it. We’re done.” That would be too late. We don’t want to create excessive volatility and jittery markets. So when the time comes, we will let the markets know about our deliberations and decisions. But the time frame is not the only element involved; there’s the performance of the economy and the uncertainty. If we see significantly less uncertainty and significant economic strengthening, then we will communicate accordingly. But this is not the moment yet.

Q: There may be a need to make a decision even under high uncertainty.

A: Of course. We may need to do so. But currently, there is no need to do so. We still have time, current uncertainty is still high and the current support measures seem to be sufficient.

Q: There are only two meetings between now and March at which staff forecasts are updated, and September is fairly soon.

A: I won’t speculate about specific dates, but of course we need to have a discussion within the Governing Council, and currently I don’t feel a need to hurry with that.

Q: What was the significance of last Thursday’s reconfirmation of the asset purchase pace? The June announcement applied until September anyway.

A: I think confirming that things have not changed in that respect provides more comfort to the markets. And I think that what was very clearly communicated Thursday is that at the current moment, we have looked at the forward guidance for interest rates only. As for the rest of the forward guidance, if we see the need, then it will also change. Restating for now our intentions about asset purchases may have prevented anyone from thinking that maybe we just dropped that. We want to reduce risks of misunderstanding us.

Q: So it was just the new context of the new strategy and nothing beyond that.

A: Yes, yes. I would agree. There was no hidden agenda behind this.

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: We will have this discussion. It’s not an issue at the current moment. The PEPP is still working, the size of the envelope is still appropriate and there’s still sufficient time, so there is simply no need to rush with these issues. In due time, we will discuss it and then we will see. One other thing I want to stress is that we have a wide set of instruments, and if we see that they are not sufficient, then we will devise new ones, within our mandate of course and in line with our analyses of proportionality and legality and so on. At the current moment, there’s no need to do all this, but in due time, we will come back to it. But just to stress it once again, the end of PEPP does not mean the end of support to the economy. We have other programs that will support the economy, and if we see that we need some additional, transitory elements, then we will discuss it. Flexibility is important. It’s going to be state-dependent and we will act as best for the economy.

Q: So one way or another, the ECB will ensure that it continues to have the means to respond flexibly to the issues that motivated it to create the PEPP in the first place.

A: Yes, yes. What we saw from the crisis is that flexibility is important and that using a set of instruments is more efficient than using a single instrument. This is to address various risks including fragmentation. We also have other instruments that we’ve used in the past but are not using now. However, this discussion is premature. We will discuss this when it becomes topical.

Q: What can be said in response to the view that the ECB’s reluctance to cease providing the current high level of monetary support is all about ensuring that peripheral countries don’t suddenly find themselves paying unsustainably high yields to incur more sovereign debt?

A: I love this question, because it gives me another chance to explain our mandate. Our mandate is price stability: 2% symmetrically over the medium term. The medium term of course can be state-dependent in terms of the kind of shock, what instruments are best used, the proportionality analysis and other things discussed in the strategy statement. Our task is not allowing governments to run deficits. We are not falling into the pitfalls of fiscal or financial dominance. Our task is price stability, and we will act in line with this. At the current moment and so far, we have seen that monetary support of the economy has gone hand-in-hand in the same direction as fiscal support of the economy. We have stressed very often that what’s important is not fiscal support per se; it’s very important to consider the structure of fiscal spending. Fiscal spending needs to be targeted and improve the underlying productivity outlook. Will these two policies be aligned in the future? Not necessarily. When we see that inflation is meeting certain criteria in line with our strategy and our forward guidance, of course we will move with both asset purchase levels and interest rates. That’s why fiscal policy also has to be forward-looking. At the current moment, it still has to support the economy. But at the end of the day, the issue of debt sustainability has not disappeared. That element is still important. So we will act in terms of our mandate, providing price stability. And of course we will take into account the overall impact of our moves on the economy. But we are not talking here about a risk of fiscal or financial dominance.

Q: One can’t help noticing however that it is the peripheral countries that tend to want to do more for longer in terms of monetary support, and the Northern, fiscally conservative ones that are most inclined to withdraw that support.

A: I can’t comment on specific countries, but monetary policy is of course run for the whole of the euro area. There is significant heterogeneity across countries, also in terms of the recovery, and of course, that may complicate the decision-making. That’s why we very strongly argue that structural issues are extremely important.

Q: The idea has been floated of hiking interest rates before asset purchases cease completely. How would you regard changing the usual order of things in this way?

A: We would need to discuss that. The current forward guidance for asset purchases is as it is, and when we see that it’s necessary, we will discuss it. The current story goes that raising rates without reducing asset purchases is at odds, contradictory. Current understanding is that asset purchase volumes get reduced and then rate hikes follow. But I would not speculate at the moment. We will see how our discussions go and we will see how the economy develops, and then we will address it.

Q: Does making asset purchases a standard instrument, as the strategy review has done, have a bearing on this?

A: There was still a pecking order in the strategy statement saying that interest rates are the principal tool, but given what we’ve seen over the last decade with r* and the issues at the effective lower bound, there are instances when other measures that used to be called nonstandard are very appropriate. But there is a certain pecking order for what instruments you use when you are away from the effective lower bound. The effective lower bound really makes all the difference.

Q: What can you share about this Governing Council meeting in terms of atmospherics and the nature of the discussion?

A: I will stick to what President Lagarde said: on strategy, we had unanimous support. Last Thursday, we had an overwhelming majority as to the exact wording of the forward guidance. Another thing to stress is that everybody saw that forward guidance needs to be adjusted. And where we saw some difference was about exactly how the wording should be adjusted, but not about the principle. But after all, with 25 individuals around the table it would be very unlikely that we all think exactly the same. I think that is the strength of this group: we come together with different views and opinions, but through discussion, we arrive at a result that encompasses all or most of the views. So far, it has worked. So all respect to the President, who has skillfully helped us to reach an agreement.

Q: Recent comments by her suggest that she expects less unanimity going forward.

A: There are two issues. One is agreement on the overall strategy framework, and agreeing on that unanimously is critical. But the other issue is operational decisions, and it may not always be the case that we agree 100% on these. It would simply be very unlikely that we always and at every moment agree 100%. You can drive from Frankfurt to Paris, for example, using different routes. But we have all agreed in effect that we are going from Frankfurt to Paris. Some of us may want to take a detour here, others there.

Q: Was the unanimity on the strategy not achieved mainly just because the hawks did not want to be perceived as obstructionist?

A: I would not agree with this. That suggests a picture involving solutions at opposing corners. There are so many things that we agreed on during the review, including many things that at the very beginning many thought would be impossible to agree on. The common discussions that we had over quite a lengthy period about extremely varied topics relating directly and indirectly to monetary policy drove us towards this consensus. I would stress the agreement that we have on all these different issues rather than picking out some of the things that were not included in the strategy. Of course, with so many people there will always be some points you don’t agree on. But the strategy is very comprehensive. It makes the ECB and the euro area ready for the future from many different points of view, starting with the effective lower bound and ending with climate change. These are things that weren’t even part of the previous strategy, so it was not ready to address them. Now we are. One should not be naïve and expect that this is the ultimate strategy and with us forever. It’s not the New Testament. It’s going to be reviewed and if necessary also revised, and we can even put in the calendar when: 2025.

Q: Do you share the view, to use the words of one of your colleagues, that rising inflation expectations ‘suggest that the exit from the pandemic provides, for the first time in many years, some ground for cautious optimism that the euro area economy may eventually escape the low growth, low inflation environment that has dominated the macroeconomic landscape for most of the past decade, with inflation eventually converging sustainably to levels closer to 2%’?

A: Is it good that inflation expectations are going up? Yes. But are they at a level where I would be happy? No. I would of course very much like to see inflation expectations move closer to 2%.

Q: What about the possibility 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’, to cite the account of the last meeting?

A: Let’s see how the inflation story develops in the US. One interpretation is that markets have over-reacted to the risk of sustained very high inflation. And so now we see that the inflation story seems to be less prominent. Coming back to the euro area, numbers like those currently in the US are not in the cards. And the major reason for that is the labour market. For inflation to be persistently high, we need the labour market to join in. And if we look at wage growth, it signals that there is still significant slack. It’s just way too early to say. Going forward, of course there is yet another element that may add to inflation, and that is climate change and related transition costs. Higher CO2 taxes may drive inflation higher. We don’t know yet, so it’s difficult to factor in. We’ll see. But at the current moment, I don’t see the risk of runaway inflation in Europe. And even if it happened, we would know what to do about it. Of course, when hiking interest rates one has to be cautious and weigh the risks of how it affects the economy, avoid hiking rates too early and sharply. So one has to be cautious and forward-looking. But we know what to do if inflation goes up.

Q: How do you understand ‘a transitory period in which inflation is moderately above target’?

A: It’s as simple as 2%, symmetric over the medium term. We target inflation at 2%, we do not target inflation at above 2% to compensate for past shortfalls. But for instance, if we see inflation moderately above 2%, but also see that due to past shortfalls instance inflation expectations have decreased with a risk of dis-anchoring, then in such circumstances I would consider it possible or even necessary for us to wait somewhat before acting until inflation expectations recover and climb closer to 2%. So the patience to overshoot temporarily and moderately is for the purpose of stabilising inflation around 2%, but not to achieve inflation significantly above 2% for long periods of time to compensate for shortfalls. It’s only to get inflation symmetrically around 2%.

Q: Going back to inflation in 2023, can you confirm that you see risks to the upside?

A: I am more hopeful about inflation at the end of the forecast horizon. With the new strategy and the new forward guidance, I would see inflation somewhat higher than we currently project it, but we will need to discuss it and see how the economy develops. Covid is still a major risk.

Q: Is the disappearance of the Covid story the definition of the crisis phase?

A: We’ll need to discuss that one as well. PEPP was created for the pandemic emergency, but then the natural question is how exactly you measure the emergency.

Q: How much does it matter, or is it all about the pandemic-related shift in the path of inflation?

A: Ultimately of course our target is inflation, and when we move out of pandemic mode, inflation is going to be the priority. Throughout the crisis, we also had inflation in mind, but with such a negative shock, you have to stabilise the economy first, and then you can think about the inflationary target. So we dealt with the pandemic, and then we go back more to the usual mode of operation, which means getting inflation back to where it should be.

Q: How do you see yourself in terms of hawkishness/dovishness?

A: That is a very interesting question, because I’ve seen rankings where I’m a dove and rankings where I’m a hawk. At times, I think, such a division is very subjective and even counterproductive. My view is that when a negative shock hits, then monetary policy has to support the economy. And moving earlier and more forcefully could have certain benefits. But when the recovery takes root, then monetary policy has done its job and other policies have to take over. It’s state-dependent. I don’t want to classify myself with either the hawks or the doves. It depends on the situation. But what’s important to stress is that monetary policy should not be the only game in town. Fiscal policies and structural policies are an integral part of the policy mix. Monetary policy should not and cannot do all the heavy lifting.