Paris French central bank chief François Villeroy de Galhau sees good chances of resolving the conflict over the ECB’s bond purchases with the Federal Constitutional Court. “There is now a good chance that a solution is close to answering Karlsruhe,” he said in an interview with the Handelsblatt.
In view of the economic burdens caused by the corona crisis, the French central bank chief considers it normal in the short term that the European states support the economy and their public debt increases. “The euro countries should reduce the debt in due course.”
The procedure could vary from country to country. In France, it will also be about better controlling spending. “We have to use public funds more efficiently, as Germany did before. It will be important that a medium-term debt reduction policy is clearly communicated and represented. ”
Regarding the duration of the bond purchase program in the corona crisis, called PEPP, Villeroy said: “We could clarify the criteria with regard to the economic situation (” state dependent “), upon which we stop the program.” He was also open to one Banks are less relieved of negative interest rates through higher allowances. He was one of the biggest advocates of tiering rates, and they were a huge success. “If we can optimize the allowance in the future, why not?”
Villeroy believes that a debate on the ECB’s possible purchase of junk bonds is “probably not urgent”. It is out of the question that one buys bonds that were rated “Ramsch” status even before the crisis. A downgrading of companies that were previously well rated during the crisis could, however, reinforce an already negative trend. “We therefore have to check whether we can slightly reduce the dependency of our monetary policy on the rating agencies, but in any case we have to take the risk of the securities into account.”
Read the entire interview with the French central bank chief here:
Mr. Villeroy de Galhau, the ECB expects economic output to plummet this year. How bad is it going to be
The crash was absolutely brutal, but we’ve got the worst behind us. In France, the economy plummeted by 30 percent. We quickly made up for more than half of the losses. The further catching up process will proceed more slowly in the form of a bird’s wing, a V with a flattened right bar. I expect something similar for the euro area as a whole. The latest IMF forecasts are too pessimistic for Europe.
Who suffers more from the corona crisis: Germany or France?
In general, the burden on the health system in France and southern Europe was greater than in Germany and northern Europe. From an economic point of view, there are unfortunately hardly any differences. The measures to contain the virus have unfortunately hit the economy hard everywhere. Germany is also unlikely to reach pre-crisis levels before the end of 2021. If some countries were less affected, that would be good news for Europe.
So you don’t see any major differences?
There are fewer differences at the economic level than at the health level. The shock is largely symmetrical. It is important that we react in a coordinated way to end the crisis so that differences do not increase.
What do you think of a coordinated response?
The most important step is the Franco-German proposal for a European reconstruction fund. This means that the risk of monetary policy overload is reduced and that fiscal policy also plays a more active role in the reconstruction of Europe. In addition, the EU Commission will soon have to decide on public aid for companies again. In the crisis, it was important to give national governments freedom here because of the urgency. However, this should not be a permanent condition. Otherwise we would create distortions of competition in the internal market.
“Europe must not repeat the mistakes made ten years ago”
A foreseeable consequence of the crisis is a dramatic increase in government debt. There are demands that the ECB should help the euro area countries to deal with the debt burden, for example by buying perpetual government bonds. What do you make of it?
As governor of the central bank, I can only strongly remind you of the European treaties, which rule out such a thing. The treaties bind the states, but they are also a pact of trust towards the citizens. They are the basis for the high level of trust of 76 percent of citizens in the euro. The ECB cannot assume government debt.
Are they not worried about the level of debt?
In the short term, it is normal for European countries to use their financial leeway to push the economy into recession. Even after the crisis, government debt in the euro area will remain below the level in the United States, Japan and the United Kingdom. The euro countries should, however, reduce their debts in due course.
When should that happen?
If the economic recovery is robust enough. Europe must not repeat the mistakes made ten years ago when debt consolidation began too soon after the crisis. The procedure can vary from country to country. Time and growth will play a role in France, but it will also be about better controlling spending. We have to use public funds more efficiently, as Germany did before. It will be important that a medium-term debt reduction policy is clearly communicated and represented.
Last week, the ECB granted long-term loans (TLTRO 3) to banks in the euro area worth EUR 1.3 trillion. What do you want to achieve with it?
Companies and households in the euro area are financed mainly through the banks. We want to make sure that they get enough credit in the crisis. The TLTRO3 is a great success, especially for Europe.
The new long-term loans increase the surplus liquidity of banks in the euro area. They have to pay minus interest for excess liquidity. Since last year, however, the so-called tiering has given an exemption that is exempt from this. Should this allowance be increased?
I was one of the biggest advocates of tiering and it’s a huge success. The aim is to guarantee the economy and companies very low interest rates without affecting the intermediary function of the banks. If we can optimize the allowance in the future, why not?
“The ECB must be guided by two anchors”
Should the ECB also buy junk bonds as part of its PEPP crisis program?
The debate is probably not urgent. I rule out that we buy bonds that were rated “ramshackle” before the crisis. On the other hand, if the rating agencies downgrade well-rated companies during the crisis, this can exacerbate an already negative trend. We therefore need to check whether we can may slightly reduce the dependency of our monetary policy on the rating agencies, but in any case we have to take the risk of the securities into account.
The ECB has recently increased the volume of bond purchases under the PEPP crisis program by EUR 600 billion to EUR 1.35 trillion. What is the goal?
The ECB must always be guided by two anchors: its independence and its mandate of price stability. If the goal of price stability is in jeopardy, as is the case today, we must react accordingly. The PEPP purchase program is an extraordinary instrument in an extraordinary crisis.
Why is it extraordinary?
As its name shows, the PEPP is a temporary instrument tied to the corona crisis. We could clarify the criteria with regard to the economic situation (“state dependent”), upon which we stop the program. The other difference from previous bond purchases is that we have greater flexibility. There is an overall ceiling, but there is no obligation to reach it if the situation improves. And there is no fixed monthly purchase volume. It is also crucial, as President Lagarde emphasized, that monetary policy is well received by all euro area countries and by all actors. Thanks to the flexibility within the PEPP program, we can achieve a higher efficiency and at the same time control the volume better. Since we adopted the PEPP on March 18, government and corporate bond markets have been functioning normally: good news!
How long do you want to continue the extremely loose monetary policy?
This depends on the inflation outlook. Here I am very close to the traditional German position that we have a central mandate, price stability. Looking at inflation in the euro area, it was only 0.1 percent in May. An average of 0.3 percent is forecast for the year as a whole. This value is far below our target of “below, but close to two percent”. If we take our mandate seriously, we need a very flexible monetary policy until the goal appears clearly achievable.
In its judgment on the older PSPP program, through which the ECB has been buying government bonds since 2015, the Federal Constitutional Court wrote that this was not government funding through the banknote press. However, it emphasizes the binding of purchases to the ECB’s capital key. With the PEPP program launched in the corona crisis, you don’t want to stick to this limitation. Is there a new dispute between the Federal Constitutional Court and the ECB?
The decision of the Constitutional Court only affects the PSPP. There is now a good chance that a solution is close to responding to Karlsruhe. In fact, our decisions are obviously proportionate and the European Court of Justice has confirmed that.
“Our job is to ensure price stability”
The ECB has provided the Bundesbank with internal documents which it will forward to the Bundestag and the Federal Government.
Recently, there has been good progress in the method used to document our decisions, a method that respects both the independence of the ECB and that of the Bundesbank.
How important is the capital key for you, i.e. the limitation of the purchase of national government bonds to the capital share of the respective country?
It is absolutely crucial for the PSPP. For one simple reason: the aim of the PSPP is to permanently solve the problem of low inflation in the entire euro area, which already existed before the crisis. Its effectiveness depends on its predictability, so we have to stick to the capital key. At PEPP, this key remains an important benchmark, but it is not the only one: we also need to ensure that monetary policy transfer is fully effective in any country given the risks of fragmentation posed by the crisis. I also support what my friend Jens Weidmann said: There is no question that the ECB will provide a guarantee for government debt or guarantee a certain interest rate differential (spread) between euro countries. Our job is to ensure price stability.
You recently criticized attacks on the independence of the ECB by both the Federal Constitutional Court and certain countries such as Italy …
… or from France. Karlsruhe is different.
What exactly do you mean?
We are faced with a paradox. At the very moment when the ECB is particularly active and innovative, voices are being heard in the countries mentioned that demand: We have to put the ECB under political control! We have to change their mandate! You can sometimes hear both demands at the same time. But for me, independence is not negotiable.
There is some uncertainty about the ECB’s justification for its policies and accountability. Christine Lagarde says she wants to bring the ECB closer to citizens – will that also be an opportunity to better clarify accountability?
I cannot ignore the suggestion that the ECB, the Banque de France or the Bundesbank are not accountable. We are institutions created by democracy based on treaties that define our mandate. The President and the members of the Executive Board are appointed by the heads of government and endorsed by the European Parliament. The ECB reports regularly to the European Parliament. As part of our strategy review, we can improve our communication with citizens: the debate was undoubtedly too limited to specialists and the financial markets. Can we explain monetary policy to the general public? It is a challenge, justified, but difficult. Should we extend accountability to parliaments? Maybe. But nobody should try to play democracy and independence against each other.
“States remain responsible for their existing debts”
In a broader sense, what are the consequences of the corona crisis for the ECB’s strategy review?
The first consequence is that we had to move it from spring to autumn. Then the corona crisis intensifies the deflationary tendencies that are weighing on our economies, above all because demand picks up again more slowly than supply. We have to take that into account. It remains with our anchors, independence and mandate for price stability. It is out of the question to give in to fiscal dominance, i.e. to distort monetary policy in such a way that it eases the burden of government debt. Perhaps we will clarify the inflation target and in any case confirm that it is symmetrical, that is part of its credibility. If there were an upper limit below, but close to two percent, the goal would never be achieved.
Are you sympathetic to the idea of being close but below two percent on average in the medium term? Then, after a long period of time near zero, would inflation have to be around two percent for as long?
I have neither sympathy nor antipathy for that. The possibility of a temporary average inflation target is a debate that comes from the United States. The question is whether we could compensate for the failure to meet the inflation target since the beginning of the crisis by aiming for a slightly higher inflation later on. This is an open question that can be addressed in the strategic review.
The US Fed is concerned with controlling the yield curve, could you join in?
As far as I know, the Fed has not yet decided. That would be much more difficult in the eurozone because we have 19 sovereign issuers and not just one as in the United States or Japan. Which yield curve should we consider? I repeat that it is out of the question to give those responsible for the budget in the euro zone a guaranteed return. That would be a false incentive that could lead to irresponsible policies.
You mentioned the Franco-German initiative, which involves a qualitative leap: common debt for a common response to the crisis. Does this also end the debate on Eurobonds?
You know me, I have been saying for a long time that there is no point in spending a lot of energy on a debate that leads to nothing. Let us be clear: States are and remain responsible for their existing debts.
They are left out of the reconstruction fund, so the debate is over?
The Franco-German initiative is something else: we have an interest in jointly financing a task that we are faced with, namely post-crisis reconstruction. But I insist: part of the expenditure has to be used for cross-border projects that offer European added value. These cannot simply be existing national investment projects. We all have to get the energy and digital turnaround: let’s use reconstruction to invest together and review a carbon tax. Unfortunately, in the debates between Member States in recent weeks, I have heard less about these common tasks. And they are a huge challenge. If we deal with it, the Covid crisis would become an opportunity.
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