TRANSCRIPT: Interview with ECB Governing Council member Wunsch on 13 October 2023
16 October 2023
By David Barwick – MARRAKECH, Morocco (Econostream) - Following is the full transcript of the interview conducted by Econostream on 13 October 2023 with Pierre Wunsch, Governor of the National Bank of Belgium and member of the Governing Council of the European Central Bank.
Q: Governor, would you agree that the current situation with Italy is the perfect example of when it would be inappropriate to use the TPI?
A: I said at the ECB watchers conference last March that we've been flirting with a weak form of fiscal dominance in Europe. When we constructed the euro framework and concluded the Treaty and so on, the idea, obviously, was that there would be enough fiscal discipline for monetary policy to operate without any consideration of fiscal sustainability. We’re past that. We know that the interaction between fiscal and monetary policy is sometimes more complex. For example, economic support during Covid is a use of the fiscal channel, because when people cannot leave their home, reducing interest rates is not going to help them directly, but it does allow for a stronger response from fiscal authorities. More recently, the fact that we were stepping on the monetary policy brake while some countries were pushing on the accelerator in terms of fiscal policy was not being helpful. So, we have those interactions and we need to recognise them. But still, the rule of the game is that a priori we should be able to conduct our monetary policy without being preoccupied by fiscal sustainability and the budgetary policies of specific member countries. In any case, I am hoping and pleading for reopening the discussion on possibly ending PEPP reinvestments sooner. Because honestly, considering the current situation, I just don't see any monetary policy argument for continuing to reinvest, other than that we said we would. And of course, the fact that we said we would reinvest and the nature of a commitment are part of the discussion. But here, I think it would not hurt us to reopen the discussion and tell observers that the situation has changed, so that we need to reconsider the appropriateness of these reinvestments.
Q: Could you envision someone in similar circumstances saying, ‘Well, Rome may be partly to blame, but the markets have gotten carried away, which warrants the ECB’s involvement’? In general, can you distinguish between the extent to which it's domestically caused and the extent to which it's unwarranted?
A: In many cases, it’s going to be 50 Shades of Grey. That said, [Banca d’Italia Governor] Ignazio Visco has been quite clear that what we see today is a consequence of the deficit being too high in Italy. And if the problem is that the deficit is too high, the solution is that the deficit should go down. Now, in the meantime, if there is the political will and a plan to remedy the situation, and yet for whatever reason we feel that the movements in the markets are too brutal, then we will have that discussion. So, as I see it, we can have a mix of warranted and unwarranted, and distinguishing between the two is not easy. So, it is not all black or all white, though what we see today - and again, I'm referring to Ignazio’s comments - is above all just a government announcing, ‘Sorry, our deficit is going to be too high because we took some fiscal measures that cost more than expected.’ And that's a negative surprise, but they explained it and there were some controlled market reactions. So, the situation is quite clear so far. And we'll see what the future brings, but we're not going to check the TPI conditions every day and say, ‘We are in the red zone for one country and in the blue zone for another.’ The day we feel we have to check the conditions and form an opinion on whether developments are warranted or unwarranted, we’ll do that.
Q: A colleague of yours has observed that there's a cost to reneging on forward guidance, referring to the promise that maturing securities under the PEPP would be reinvested until at least the end of 2024. Judging from your previous answer, do you feel that earlier guidance shouldn’t be blindly followed when fundamental circumstances change?
A: When you’ve announced a commitment, there is a cost to changing that. But my point is that if there’s any reason to invest until 2024, then that commitment would be the only reason. Whether that reason is strong enough deserves to be the subject of discussion, which is probably my way of telling you that although, there is indeed a cost conceptually to reneging on forward guidance, we've done it before, and I think in this case the cost would be relatively low.
Q: Very low, because the markets would have to understand that it's really not justified to continue to blindly adhere to your guidance after circumstances change fundamentally.
A: That's the philosophical discussion on whether forward guidance is conditional or not, as in, ‘I'm going to do crazy things, no matter what.’ That vision of forward guidance, that it's not an indication of what you believe you're really going to have to do anyway, but of what you are going to do regardless of whether it’s good policy, some people say is the only forward guidance that works, because any other form is just too conditional.
Q: Does it not all come down to how well a change is explained or communicated?
A: Yes. When we decided to extend PEPP it’s because we believed we still had a problem of inflation being too low, and this is clearly not the case anymore.
Q: So, you said that you were in favour of at least reopening the discussion around PEPP, which I found to be a cautious formulation. To go back to an expression you've used before in another context, isn't it actually a no-brainer to reopen the discussion and even make a decision soon?
A: I said that I saw no reason why we should reinvest until the end of ’24, except for the fact that we had announced we would.
Q: Which one could say makes it a no-brainer?
A: Yes.
Q: And given that you have relatively little to do at the October meeting besides considering whether things are evolving in line with your last forecasts, wouldn't it be appropriate to start that discussion then and to come to an actual decision?
A: The timing of the discussion is the prerogative of the president. I'm pleading for not waiting too long before we have that discussion. If it's in October, fine; if it's a bit later, I’m fine with that as well. I don't see it as a pressing issue. I think of it more as a consistency issue: we’ve hiked interest rates a lot and are now in restrictive territory. Of course, there is some uncertainty about how restrictive, but we stopped APP reinvestments, so it naturally feels like one of our instruments is out of sync with the rest and we need to indicate an intention of making it consistent with the others.
Q: And do you see a need for a long lead time between making the decision and implementing it, like an entire quarter?
A: Let me put it this way: I don’t think there is any need for us to be brutal about any change we would make. We were cautious about changing our approach to the APP, and we can be cautious with changes to the PEPP.
Q: How much of a tightening impact would you expect to result from this?
A: I would express it as follows: the markets will have to learn to live without us buying and being present in the market. There is some uncertainty about the impact we're going to have. We don’t want to rock the boat. When we stopped APP reinvestment, we did it progressively so that we could see whether at some point we were generating some movements in the market that we didn't like and that could justify corrective action by us. And my assumption would be that we're also going to be cautious about what we do with the PEPP. But we need markets to relearn to live in an environment where we're not buying large amounts every month.
Q: Three months ago, it seemed like everyone was in favour of being very cautious to the point of not even really wanting to change anything about the PEPP.
A: If you look at it from a monetary policy perspective, rather than focusing on the flexibility aspect of the PEPP, then it's about the size of the balance sheet. Sure, some people in the world still get Covid, but not so many.
Q: But going back to your view that a cautious approach is appropriate, I would think that you could express more confidence about the ability of markets to digest this.
A: It's not that I'm worried. But I don't see any urgency on the monetary policy front to use the balance sheet in terms of stance, in the sense that there is something we could not do with interest rates that we instead have to do by using the balance sheet. From that perspective, it means that we can be cautious in moving, because there is no upside in rushing this, and at the same time, there is an upside in being cautious. But this doesn't mean that I have the impression that it's very dangerous.
Q: So, to be quite clear, the additional tightening effect is not the motivation here.
A: There will be some tightening, and of course it's more about the long duration part of the curve. And if our stance is becoming restrictive, we want to make sure that we don't overburden the short term compared to the long term. But it's not like, ‘Oh, we need to be more restrictive, and it's the only solution we have, and we have to do it quickly.’ Not at all.
Q: To some extent it has seemed like that, just because this is all occurring at the same time as you’ve apparently reached the end of your rope with respect to interest rates.
A: Yes, but that's where if you ask me whether we’ve reached the terminal rate, I’m only going to answer, ‘Maybe, maybe not.’ Meaning that if we have some bad surprises on inflation - and we've been surprised before, so I cannot guarantee that we're not going to be surprised again – I would still want to rely on rate hikes as the signalling instrument, more so than the balance sheet, just because that’s easier and more flexible.
Q: It's clear you retain the option, and no one knows what the future will bring, but if we’re going to use the word ‘surprise’, then isn’t it fair to say that it would also be a surprise if you had to hike rates again?
A: When you’ve been surprised so much over two years, the question is whether a surprise is really a surprise. Honestly, when I see that the UK, the US and Canada have all paused and then had to hike again, I think the chances that we would have to do the same are far from marginal. Though the base case is that we don't have to hike anymore, and I take some comfort from the fact that core inflation developments have been in line with our forecast over the last three-four months, which had not been the case for a long time. Our projections were revised 1% every time, so we could not use them as an anchor. Now I think you could start using them as an anchor. So, we expect to reach 2% in 2025. It's in our projection, essentially with the interest rate level we have now. So, the way I look at it is quite simple. We have that anchor. If inflation developments go above that - not marginally, I'm not a fetishist, so it doesn’t have to be exactly 2.0 - but if they go meaningfully above that, then we need to do more. And we're going to have to signal that by hiking. I don't think we can rely on some form of forward guidance where we just say we’re going to keep rates where they are for longer. If we have inflation developments substantially in excess of what we’ve projected - not just by 10bp but more - then we will have to hike again. That we now have time and can pause and collect data and wait until December or January to take stock of the situation – I’m completely fine with that.
Q: We're going to have the 2026 forecast for the first time in December. We already project HICP of 2.1% for 2025, with 2% by the third quarter. If the 2026 forecast is around 2%, your job is done, no?
A: I'm going to refer to the speech that Christine Lagarde made at the BIS. She said we need to be humble and she asked a number of questions about the models. We know that the quality of the projection a year plus two or a year plus three forward has been very bad. When we moved to data-dependent mode, it was a recognition that the comfort we got from projection ‘T plus two’ was very low. Just because we’ve now had three or four inflation readings in line with our projection over a very short-term horizon, it’s not that we suddenly have a huge amount of confidence in the projections two years ahead. The likelihood that we're going to be faced with some resistance around 3% or 3.5% is real, considering wage developments. And we won't know until we are there.
Q: This is where core comes into the game, right? So that you can be reasonably sure that you’ve stably achieved price stability.
A: Yes, but it's not only core, because wage developments will be related to headline inflation. And with oil prices going up, I think the momentum in headline inflation has gone up again. It's over 4%, maybe even close to 5% now, depending on the measure you use. Every month where you have headline inflation around 5%, it's going to feed through wage developments. I'm not saying suddenly that core inflation is going in the right direction, so I'm going to look at headline inflation to find an excuse to be hawkish. Core developments are going in the right direction. But we are faced with higher oil prices. And I don't know if it's the end of it, given the Middle East situation. Assuming there won't be any shocks from now to the end of ’25 is a risky assumption, and shocks can go both ways. That’s a long story to say there is a lot of uncertainty, and so I don't know if we’ve reached the terminal rate.
Q: What do you anticipate for the 2026 projections?
A: I don’t know, but honestly, I don't care so much.
Q: A little bit, surely.
A: Not even. To me, what we get in ’26 is going to be information about the structure of our model more than anything else. I can bet it's going to be close to 2%; that’s the way the models are calibrated. It's a long story, but at the end of the day, most models - not all – are mean-reverting or stationary, and they go back to some form of anchor. And then you can have a discussion about where the anchor’s coming from. So, most projection exercises over the medium term don’t really tell you much about anything besides the structure of the model.
Q: To go back to the subject of the balance sheet for a moment, when do you think we can get to actual sales instead of just a passive roll-off?
A: First, we have to settle on an operational framework and decide what amount of excess reserves we want. And then we have to ask, what is the level of liquidity in the system, how do we project that level to decline, and do we need to do outright sales to reach that level within a reasonable timeframe? Conceptually I'm certainly open for the discussion, but I'm far from sure that we are going to need to do outright sales. My base case is that we're just going to run down the balance sheet without sales. And to be frank and honest, part of the reason is that we are going to make losses. If we frontload the losses, it will have a political cost. But to be consistent, let's first have the discussion on the operational framework. And then, on the basis of that, we'll have a discussion on how fast the balance sheet needs to go down.
Q: But even before the discussion on the operational framework, you can discuss the PEPP and the forward guidance.
A: Yes, because in the case of the PEPP, we have an instrument that, in terms of stance, is going in one direction, whereas the other instruments are going in the other direction.
Q: Do you think that the tightening effect of a decision to stop these reinvestments would have a material impact on key macroeconomic variables and the projections?
A: I don't think so. I have the impression that high for longer and the end of asset purchases have already been priced by markets into spreads, so I think it’s been largely anticipated. Of course, sometimes we do something we think has been anticipated and priced in, and yet we still see a reaction, which is also why I think we need to be cautious.
Q: Is there some level of the balance sheet that you have in mind that you'd consider it appropriate to get to by some particular point in time?
A: No. It's part of the operational framework discussion. If you ask about my view of the operational framework, it's not obvious to me that we cannot go back to the previous framework and that we need excess liquidity in the system forever. The fact that we need instruments to be able to react quickly if there is any kind of shock in terms of liquidity provision, which could go in the direction of what they want to do in the UK, i.e. some kind of system where you have full access to the balance sheet of the ban and would remain with some kind of full allotment, that's probably going to be part of the discussion. But I'm not convinced at this stage that we need perpetual QE and an ECB portfolio with a significant presence in the markets.
Q: If we get a 2026 forecast in line with price stability, will it in any way limit the room to do something with QT, given that anyone opposed to adjusting QT could argue that there is no need for any further policy tightening, even if the tightening effect is not the objective?
A: We have a projection showing a return to 2% at the end of ‘25, which is already relatively far away. What I'm going to look at now is whether inflation developments are in line with the projection. If they are, then we’re at the terminal rate, we don't have to do more and that’s fine with me. If we project 1.7% in ’26, I don't even care. That projection is going to be revised again and again before we get there. So, we have a path going to 2%. Are we on the path or not? If we are, fine. If we are not, then a little asymmetry is justified in the sense that even if inflation developments were to be on the low side compared to the path, the end of ‘25 is still far away, so I wouldn't jump to cut rates because we have two or three readings below the projection. On the other hand, if we have two or three readings significantly above the projection, then I think we need to do more.
Q: Still, without wanting to tighten too much.
A: No, we want a soft landing. I can confirm that. We might end up in a situation where we don't get the soft landing, but that's what we're aiming at.
Q: To the extent that you're able to accelerate the speed at which the balance sheet is reduced, does that not inevitably, mathematically, bring forward the earliest date at which you can loosen monetary policy in terms of interest rates?
A: Directionally, yes. Is it quantitatively significant to the extent that markets would have already priced in what we’re going to do? It might not be very significant.
Q: Even in the trade-off sense of some colleagues arguing that we’re making all this progress on the QT front now, so there’s room for a small rate cut sooner rather than later?
A: Sure, we can be very sophisticated. But the thing is, we are confronted with a lot of uncertainty. We've been wrong in terms of estimating the persistence of inflation for a long time. And that's the big picture. And as for those very sophisticated discussions about trade-offs and so on, our main instrument now is interest rates. And we need some consistency in terms of the balance sheet, but at some point, we are going to decide about running down the balance sheet. And then that will just be a train that has departed, and the marginal instrument will remain interest rates.
Q: On another topic, nobody's talking about the exchange rate lately, but in the middle of July, just three months ago, the dollar was at 1.12 per euro. And now we're at 1.05. That's a pretty substantial decline.
A: The pass-through of the exchange rate in our models is relatively weak and slow-moving. But it will be in the projections in any case, so if there is indeed a depreciation of the euro, it should, all things equal, lead to more inflation, just like higher oil prices. So, we still have uncertainty about the transmission of monetary policy, and maybe it’s stronger than we thought. We see it is strong with relation to credit developments. We have a slowdown of our economy, and inflation’s going down. So that’s confirming that the numbers currently look more aligned with our projection, reinforcing the base case where we go back to 2%. But then we have wage developments, we have the exchange rate, and we have oil prices. So, there is still risk, and this risk is far from marginal.
Q: The emphasis is all on duration right now. At what point do you think the Governing Council might be able to at least start discussing the conditions under which cutting would be appropriate, just to get on the same page?
A: There are so many potential scenarios. Let's first see whether we are aligned with the projection in terms of inflation going down. If, on the basis of all the signals that we get, we're at some point very comfortable that we’re going to 2% sustainably, then we are going to start cutting rates. It depends on so many variables: the real economy, wage developments, oil prices…
Q: Do I understand correctly though that you aren't expecting that it could come in the first half of next year?
A: I don't want even to put a date on it. One nice thing about being a central banker is not having to take positions in the market every day based on when you believe cuts are going to come. We’re in the business of getting inflation under control. We look at the data and we see what we need to do in terms of stance for inflation to go back to 2%. So, I don't need to have a strong vision on when we're going to start to cut.
Q: And looking back at the September decision, do you think in retrospect that the option to pause might not have been such a bad idea after all? What would have been the downside?
A: Most of us, maybe even all of us, agreed that there were legitimate arguments in favour of pausing, but also arguments in the other direction, so that it was not a no-brainer, but rather open for discussion. On balance, there was a majority for another rate hike. I would not make too much of that, though. It’s another 25bp, but if at some point we have the impression that the hike has accelerated the convergence of inflation to target, we might cut earlier, meaning undo the hike. So, I would certainly not over-dramatize it. We are at a point where it was not obvious anymore that we had to hike, and on balance, we decided to do it. I'm more than fine with that, but I’m not going to say that a pause would have been stupid. No - there were arguments that supported a pause. And then there were more technical arguments related to base effects in the year-on-year reading, and given the upwards revision of inflation projections, there was this feeling that if we want to be on the safe side, then we need to hike now, because of the low likelihood that we could hike in October. So, if we wanted to do a last hike, at least temporarily, it had to be in September. And then there was this broad agreement that after that, we are going to pause and take some time to see how transmission of our monetary policy is impacting inflation. And we probably don't need meeting-by-meeting to make the call; we can wait for data to accumulate and then decide.
Q: Given that you went the route of hiking, what do you expect to emerge from the 26 October meeting?
A: We're going to look at the economic situation and discuss that. And we might have a discussion on the PEPP or not, depending on whether the Executive Board wants to put it on the agenda. I'm in favour of reopening the debate, but if it’s not October, it’s not October.
Q: How receptive are you to raising the minimum reserve requirements?
A: Let’s first define the problem. What's the problem? If it's the size of the balance sheet, we have low-hanging fruit, which is reopening the PEPP discussion. Let's start with that. And then I think we need to look at the operational framework. And then we might have a discussion on whether we need other instruments to accelerate the reduction of the balance sheet. It could be sales, it could be the minimum reserve requirements. Now, the fact that we moved to zero really means that the minimum requirements is not only a decision on the balance sheet, but it's really a transfer from banks. I would define it as a quasi-fiscal instrument. Can we tax banks? Yes, we can; we have an instrument. Is it our role? And if we do it, what's the objective function? Why do we do it and what are the rules of the game? We cannot be too opportunistic on that front. Because we have never treated our profit as an objective. And I spent a lot of time explaining that we're going to make losses precisely because it's not an objective. We have a mandate, which is price stability, and if this means that we need to take positions that may lead to losses, so be it. So, we have to be cautious and disciplined in the way we treat that. If the story is about the balance sheet, there is a sequence. If the story is about something else, then we need to explain. And we need to explain what the rules of engagement are, because otherwise, we’re going to create uncertainty in the market by implicitly appearing to care about something else that we don't define well, and where we don't define the rules of engagement. And I'm probably a bit old fashioned, I believe that being independent is an exorbitant privilege. And that we really should focus on our primary mandate. And I've been saying that on other issues.
Q: You didn't make this part of your response, but you may have been one of those who within the last few months underscored the potentially difficult environment that banks may be facing before too long.
A: It's also part of the story, but to me, probably the most important part of the story in principle is, do we really want to say that our profit is part of the objective function? And if we believe it is, then let’s say it and explain what it means in a dynamic world. One concern may be – and I’m not a huge fan of QE – that the next time we need to use QE, the banks are going to reason, ‘They're going to use QE, they're going to make losses, so I need to increase my buffers.’ This is going to reduce the efficiency of the next QE round. All these things we need to be much more sophisticated about and not only opportunistic. But indeed, bank profitability in Europe was on the low side. Book-to-value ratios are low. So, some increase in bank profitability in Europe is not that bad. It's creating some resilience in the system. And now we see a number of governments feeling that bank profitability has been too high, so they’re taxing banks. But they are elected and have a broad mandate. So, I would rather have them decide whether they feel that the banks are giving enough to depositors or not. What is clear, though, is that if you increase the minimum requirements with zero renumeration, it's a tax on the bank. But the base of that tax is deposits, the way it's being computed. So ultimately, it's a tax on depositors. Now, there are a number of debates, especially in countries like Belgium, where banks have a lot of long-term mortgages, which does not give them a lot of room to manoeuvre. They've been slow, so they are under a lot of pressure. I'm not sure I want to explain in Belgium that we are taxing banks so that they can give even less to depositors because we want to recoup the losses that we made in trying to get inflation back to 2%. I'm not sure that I want to do that.
Q: You said before that it's not clear that we can't go back to the previous operational framework. Is that what you would argue for?
A: I sometimes get the impression that people take it as a given because three or four papers have been published by academics that argue that we cannot go back to the previous framework. I'm not convinced. I think going back with the required flexibility - in that you're able to switch back to full allotment whenever you want - could work. I hear people say, ‘Oh, we have to estimate the demand for liquidity. It's not comfortable. Let's not do it anymore.’ I've read [Bank for International Settlements Head of the Monetary and Economic Department Claudio] Borio’s paper on the issue. And I think the structural portfolio QE also comes with issues and risks: you make losses, you make profits, you have political debates on whether you can do it or not, you have to decide what to buy? I'm not sure it is worth it.
Q: How well do you think the most recent macroeconomic projections have been holding up?
A: We’ve had only one new reading, but it was a small positive surprise. So, so far, so good. On the other hand, we have a war in the Middle East, we have one gas pipeline that has just been blown up by someone between Finland and Estonia. So, let's wait and see.
Q: The fact that the latest ECB consumer expectations survey showed a small uptick in inflation expectations in August isn’t worth worrying about, is it?
A: No. And on the subject of expectations, the more I read, the less it seems to me that the five-year/five-year matters. When the five-year/five-year is de-anchored, it’s because it’s too late. The movement is not from the five-year/five-year to inflation, it’s from inflation to the five-year/five-year. And the literature is really telling us that price-setters and wage-setters tend to look at the past and maybe one or two years forward, not at the five-year/five-year. So, that's where you need to look. But at the same time, the explanatory power of consumer expectations, which tend to go all over the place, is not very powerful. So, it is a signal. I don't think it's a very strong signal, but to the extent that it has an impact on the wage discussion - and there labour unions are a bit more sophisticated in having those discussions - I think that's where I would look.