Interview with Público - Interview with Peter Praet, Member of the Executive Board of the ECB, conducted by Sérgio Anibal, published on 23 May 2016.
The ECB has warned about the risks of a long period of low inflation. Aren’t these two-and-a-half years of very low inflation already too much? Isn’t there a risk of the economy being already in a situation of deflation?
Our monetary policy has been very much on the alert in order to avoid a de-anchoring of inflation expectations towards a lower level. We have always said this is key. And sometimes it is difficult for the public to understand why we act so strongly, trying to avoid a de-anchoring of inflation expectations to below 1% or close to zero. The reason is that when you go from an inflation rate of 2% to 0%, in a context where you have a lot of output gap, firms with excess capacity will try to underprice their competitors, and they can do so by reducing their prices, which means that inflation will fall below zero on aggregate. You go quickly into a deflationary risk scenario. So very low inflation in the presence of economic slack is a dangerous cocktail.
Is it possible that we are there already?
What we say is that the risks of de-anchoring have increased, obviously. And that is why we acted forcefully. We have seen in some countries some signs of de-anchoring in wage formation. But, this being said, we haven’t concluded that inflation expectations are de-anchored.
Isn’t that an argument for those who say that the ECB is acting too late?
The financial crisis started eight years ago. We had eight years of very bad economic performance with two recessions during a short period of time. The first phase of our monetary policy action was basically the period between 2008 and 2009, when the ECB provided liquidity to the banks. Then we had this big fragmentation problem brought about by a very severe debt crisis. This was the second phase of the crisis, which called for a change in our policy action and the peak of that new course of action was of course the “whatever it takes” remark by Mario Draghi. Because of this change, the situation started to improve. But in 2014, the recovery was showing renewed signs of weakening, with an acceleration in the pace of disinflation which was threatening the stability of inflation expectations.
That’s when we really started to address the problem of aggregate demand in the whole union. Our policy rates had been reduced repeatedly before, of course, and in the summer of 2013 we had already reinforced accommodation by starting to offer forward guidance on the path of future policy rates. But in June 2014 we brought the rate on our deposit facility to a negative level for the first time, with three further reductions in September 2014, in December last year and in March this year. Also, we started our asset purchase programme in March 2015. And in March 2016, mainly because of the emerging markets’ shock which had weakened our outlook for price stability further, we took additional measures. With hindsight you can always say that we could have done it differently, but I think that what the ECB has demonstrated with its action is that we are absolutely determined to avoid deflation. All the actions we took to avoid a banking crisis and in the end the break-up of the euro, were instrumental in avoiding deflation.
But you didn’t avoid this increased risk of de-anchoring?
We didn’t really see high inflationary pressures in the boom years, so when the bust of the financial cycle came, after a short spike due to higher oil prices, inflation started to fall very sharply. After a renewed surge in commodity prices in 2010 and 2011, the reversal of those shocks set in motion a prolonged period of disinflation. When we realised that this process was starting to contaminate the domestic components of inflation, including inflation expectations, we acted very forcefully. We haven’t succeeded yet in getting close to 2%, but on the other hand we really have avoided deflationary conditions. So I would say, given the nature and size of the shocks, it wasn’t easy to achieve that result. Obviously, we are not satisfied with it and that is why we are persevering. And we have got the means to do it.
Does the ECB have the tools to face another shock?
The lesson we have drawn from our experience of the last few years is that we had the capacity to decide. We have a Governing Council with 19 Governors and six Board Members and we could make a decision. We could act when it was needed. We never had a paralysis problem or a chaotic decision-making process. We always had quite strong agreement on decisions actually. Not always unanimity, but very strong support.
And do you still have the instruments that are needed?
We have shown in the past that we can be very creative within our mandate. When people ask: “Are you ready for a new shock?”, I always answer: trust us, we always find the means within the scope of our mandate. Some of the measures we took in March, such as TLTRO II and the purchase of corporate bonds, have not even started being implemented. So we still have accommodation in the pipeline.
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