A generation of central bankers did not bother about inflation at all. For a year now that seems to be the only issue. What went wrong?
My predecessors and many central bankers around the world had to fight deflation, and they had to adjust policy as a result of that. More recently, we saw prices rise. And that was largely as a result of higher energy prices and supply bottlenecks. Many of us assumed that it would be transitory as is often the case with supply-driven shocks. But then came the war in Ukraine, and the rarification of supply of oil and gas and the price increases that we witnessed.
So the war changed everything…
We went from Covid lockdown with reduced activity to the reopening of the economy. You suddenly wanted to go to the restaurant or to the bar with friends. There was a surge in demand which was met by restrained supply.
Interest rates need to rise to fight inflation, but the magnitude of the increases was a surprise. How long will this have to go on for?
We had to take prompt and significant measures. In December 2021, we announced that we were going to stop our pandemic-related net asset purchases. Since July, we have hiked interest rates at a pace and size that is unprecedented. Interest rates are the most efficient tool in the present circumstances. There is every reason to believe that we will do another 50 basis points in March. After that, we will see. We are data dependent.
So the pace of increases could slow?
We will do more hikes if necessary to return inflation to our target of 2% in a timely manner. It will take what it will take. What I know is that we will return inflation to 2%. And we want to not only return it to 2%, but to keep it there sustainably. There is always a trade-off between inflation and growth. The market is factoring in a recession and a possible easing by central banks easing sooner rather than later. What is your reading?
I don’t have a timeline. I have an objective, which is our target. We need to raise interest rates to a level that is sufficiently restrictive to return inflation to 2%, and to keep rates there for as long as necessary to be confident that inflation returns to 2% in a timely manner. That’s the mantra. Hiking rates inevitably dampens demand. And what we’re trying to do is to adjust demand. That’s the mechanical impact that we expect from what we are doing. But as I said, it’s going to be data dependent. We will assess at every meeting, and we will decide meeting by meeting what we do.
Rate increases have an impact on financial markets. In a 2015 speech as IMF managing director you warned about the consequences of the lift-off of interest rates. What impact is this tightening going to have? It affected bank earnings last quarter.
In order to fight inflation, we want that our interest hikes are passed through to the financial sector, including to banks. My hope is, because we want monetary transmission to be channelled through the economy, that banks will also reflect those interest rate hikes in their remuneration of deposits. Because that really should take place.
This is coupled with the draining of liquidity. What impact would falling liquidity have, and how well prepared is the world if another crisis emerges?
First of all, the banking system is a lot stronger – the capital ratios, the liquidity ratios, the leverage – all of that has significantly improved. We are going to only partially reinvest the redemptions from our asset purchase programme (APP) as of March, which will effectively reduce the footprint of the ECB in financial markets. But we’re doing that at a measured pace. Our reinvestments will decline by 15 billion euros per month on average until the end of June 2023. It’s measured, it’s predictable, it’s transparent. Markets know what to expect.
In 2015, after meeting Prime Minister Narendra Modi and late finance minister Arun Jaitley you said “the new government is skilfully shifting the focus to good macroeconomic management, clean and efficient government and inclusive development.” Eight years later what is your assessment of India?
I haven’t studied Indian economics as much and as deeply as I did at that time because it’s no longer my job. But when I look at Indian economic data, it’s a country that has done much better than others around the world. If you look at the GDP figures, if you look at unemployment, which has increased but not in dramatic ways, I would say that there has been continued progress.
What do you expect in the coming days and years?
I see the Indian G20 presidency as a fantastic opportunity for India to draw on its own experience in the field of digitalisation, digital currency, regulatory environment for cryptocurrencies and to push that agenda on a universal basis to bring some sanity into this particular sector. India has been at it for a long time. I think that India has great experience. Both the minister and the central bank governor have put that on the agenda and I hope they will really push it. I think it’s critically important that it is done by a country like India. Another topic to push is the international financial architecture, the evolution of the development banks, the World Bank, the International Monetary Fund. India is legitimate in pushing for this.
What makes you believe that India could deliver when financial developments like these in the past mostly originated in the West?
Because I think that there is massive transformation. Everything is moving to digital. It could be that if you asked ChatGPT, it could draft this interview. Everything is now moving in a digital era with artificial intelligence and mining of massive amounts of data. India has huge expertise and is ahead of the game in many ways. The way in which you came up with the individual identification (Aadhaar) is a case in point. Nandan Nilekani was a pioneer who inspired the world with his mechanism. It was copied and inspired many corners of the world.
There is a stand-off between the Indian and European market regulators on inspection of financial institutions here. It is threatening to lock out European banks from Indian markets. How does it get resolved? Don’t we need each other at the end of the day?
We all need each other at the end of the day. I stick to my principles. I believe in the rule of law. I believe in inclusiveness. And I think that solutions have to be worked out between reasonable people who believe in these same principles. But I don’t want to take a stand on this particular issue, because it’s not my call.
Can that be resolved? During the Greek crisis you used a phrase that became the title of a book by the former Greek finance minister Yanis Varoufakis?
‘Adults in the room.’ We always need good adults in the room.
