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Welcome back. I’m Andrew Hill, senior business writer at the FT. And I’m very pleased to be back to anchor the next few sessions of this third day of our global boardroom. Christine Lagarde is exactly halfway through her eight-year term as president of the European Central Bank. As she enters the second half of her tenure, having played a major role in stabilising the EU’s financial system during the pandemic, the former IMF managing director and French finance minister is confronted with new challenges.
These are mainly around the surge in inflation that’s prompted her to raise interest rates to record highs. How she balances the fight against inflation with the need to support economic growth is likely to be among the key talking points of this next live session here in the FT studios. A warm welcome to President Lagarde, in conversation with our chief economics commentator, Martin Wolf.
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So I’m really very pleased that you’re here in our studios and to talk about the European economy and the European Union more broadly, in that context, for our audience. So let’s start–
I’m very pleased to be here too, Martin.
Good. And of course, we met many times over the years. But halfway through your term, it seems quite unreal actually. I thought it was yesterday. But there’s been a lot happening. So let’s start with what’s happening. Obviously, the European economy, like the rest of the world, has been buffeted by enormous shocks during this period, essentially, unexpected when you began. And among them, of course, has been this also very definitely unexpected jump in inflation.
Mhm.
So how do you see the condition of the eurozone economy today and prospectively, in regard to sort of economic activity and the prospects for inflation?
What I always have at the front of my mind, not at the back of my mind, is, what is the mission of the ECB? And it matters because we have a mandate, which is slightly different from other central banks. And it is– it has a primary objective, which is to procure to the euro area economies and its actors price stability. We have secondary objectives. But they can only be considered without prejudice to the first and primary objective, which is price stability.
So while obviously the state of the economy, growth in the euro area, employment, wage negotiations, and the general health of corporates as well as households, matter enormously, but I need to have my eyes focused on the price stability objective. So what we have achieved over the last– we have done a lot in the last four years.
But since inflation really changed completely the landscape of many advanced economies, but the euro area, in particular, we have significantly increased interest rates by 450 basis points. We are now at 4%, which is a very high level, relative to what has been done in the last 25 years.
And I think that the level where we are at the moment, if we sustain it for long enough– and we can debate that of course– will make a significant contribution to bringing inflation back to our 2% target in the medium term. Now, this is, of course, the loaded language that we have negotiated amongst ourselves and which tries to express that given our baseline, given what we expect of the economic developments going forward, we are at a level where we believe that if kept long enough– and this long enough is not trivial– will take us to the 2% medium-term target.
Now, two additional components maybe. Number one, this is really the baseline that we have produced in our latest projection, in September. And they’re predicated on no major shocks coming up. If major shocks come up, depending on the nature of the shocks, we will have to revisit that statement. The second thing is sustained for long enough. And for that, we are going to be data dependent.
I know that there are lots of questions around and predictions around as to, how long will be long enough? How much time will be required for that to be sustainable, as we have called it? And it must be data dependent. That’s really what we are committed to. What I can tell you, though– and I’m not contradicting what I just said– is that long enough is long enough.
And it’s not something that is in the next couple of quarters, we’ll be seeing a change. It seems to us, given the three criterias that we look at, which is the inflation outlook, which is underlying inflation, and which is the strength of monetary policy transmission, long enough has to be long enough.
So I understand that up to a point. But–
Up to a point, I doubt that. [LAUGHS]
Well, I just want to tease out this sort of high-for-long and data dependent.
I’m glad you said, high-for-long, actually.
Yes. Isn’t there a potential contradiction there or a conflict there? You’re making a promise, on the one hand, which looks like forward guidance. And if you say high for long, normal people will say, well, the president of the ECB, and therefore the ECB, is promising us that rates will remain high for quite a while. Long isn’t a day or a week or a month. I mean, it’s probably not five years either.
And at the same time, you’re saying it’s data dependent. Now, some people believe, actually, that there is quite a risk, particularly because in the eurozone, rather unlike the US, clearly, a lot of the inflation was imported, a huge energy shock. But inflation is going to fall quite fast.
And if you are, to some extent, tied, for credibility reasons, to this high-for-long possibility, commitment, that, well, maybe you delay too long because the data are never that clear. And then quite suddenly, you might find yourself back in not nicely at target, but actually well-below it again. So there’s some tension between these two perspectives.
In the end, is the high-for-long more important or the data dependence more important? How do they relate to each other in your mind?
You’re completely right about identifying that slight paradox between the two. And it is the reason why we have decided to identify the set of three criterias so that our data dependency can be well-understood by those in the markets that would like to understand where we are heading and how long our fight against inflation will last. And if we look– so we have to look at those three criterias constantly.
Some of them are, I wouldn’t say, questionable. But they are conditional upon various contingency, the state of the world, geopolitical developments, price of energy, which is not irrelevant, as you just indicated. And that has to do with the inflation outlook– underlying inflation, which requires a lot of dicing and cutting and comparing of all the measurements that we have, and then the strength of transmission, which also it’s not multidimensional.
But it is sequential. So we can see how it transmits to financing terms offered to corporates and to households and then what impact it has on the real economy, whether you look at the real estate, whether you look at investments, and so on and so forth. So I think that’s where the data dependency links, in a way, with the “how long,” so that we don’t completely eliminate the paradox, granted.
But we try to alleviate the inconvenience of the paradox by being as precise as we can be on the three criterias. With what I have said in I forgot which speech it was, but I tried to explain that we both need a clarity of purpose and clarity of objectives. We also need transparency.
And I think I’ve added a third one, which I think applies particularly to the inflation outlook, which is humility, because inflation outlook is obviously determined by our calculations, our models, what we input into models. And we have seen in the last three or four years that some of that can be largely insufficient, which is why we moved to the three criterias. And some of that has to be associated with the humility of saying, well, we believe that to be likely the case. But that could be questioned by developments, as we’ve seen.
One of the questions that, from a slightly technical, but not really deeply, so in judging this future, is how much of the tightening you’ve already done, which has been quite substantial and is now a little while ago when you started, has already affected the economy, and how much of it is still to hit the economy?
So if you think it’s basically mostly affected the economy already, then you can be quite optimistic, at least moderately optimistic about the resilience of the economy because it hasn’t done too badly. It’s not great, but it hasn’t done too badly. If you think that there’s quite a lot of tightening still to come through, the economy in the eurozone might weaken very sharply.
Is that downside possibility linked partly to this a worry for you, that you might suddenly find that actually as it all comes through over the next year or so, you’re actually confronting– given also some additional world shocks, that things are slowing elsewhere, that China is important, for example– that actually the economy is going to weaken really worryingly quickly?
You’re completely right. And that’s one of the sort of three downside risks that we identify in relation to growth. One is the price of energy.
Of course.
And the second, you’ve mentioned, it is the Chinese slowdown.
Yeah.
And the third one is an even more speedy transmission of our monetary policy. When we look at the financing terms that are available and the speed at which monetary policy stance is transmitted to the economy, we can be reasonably satisfied because there is a very, very almost immediate alignment of short-term rates, notably, to the rates that we decide. So that transmission moves quite fast.
The long end of the yield curve is different. But certainly, with the tool that we use, which is interest rates, to bring inflation down in the short term, that is moving fast. We see it. When you ask corporates what rates they’re offered by banks, when we ask, in our bank lending survey, their views about how much tightening has taken place, how much more do you expect, that has taken place, is taking place, is a lot more to be expected in the bank lending survey? It doesn’t seem to be the case.
It seems to be coming to a plateauing moment. But it doesn’t mean to say that all of it has been transmitted throughout the economy in this sequence that I was identifying, of the financing terms and conditions and then the investment decisions, the real estate, prices, and all the rest of it. So there is still probably some of it that is going to be transmitted to the economy. And it is a downside risk to growth, clearly.
Let’s talk about a few other risks. I’m not going to talk about energy because it’s not the subject that there are so many obvious risks. Can we start with–
It’s quite– yeah. Let’s–
No–
I’m following you. No, no, no.
No, if you have something to say on risks in the energy sector, I mean, the thing–
I think I’ll just mention one thing. Inflation has come down massively.
Of course.
The highest reading was October a year ago, 10.6 for the whole euro area. We’re now headlined at 2.9. It’s a huge, huge change. And one could argue that, OK, monetary policy has done its job. A bit of humility helps as well, in that regard, because I think that everybody knows and recognised that a lot of that downside has to do with base effects and the price of energy.
But we have to be really monitoring the price of energy, going forward. And even if energy prices were to remain reasonably flat now we would be losing the base effect–
Of course.
–comes January, February.
Of course.
So we should not assume that this respectable 2.9 headline number is something that should be taken for granted and for long. There will be a resurgence of probably higher number, going forwards. And we should be expecting that.
Well, you clearly won’t have the contribution of a massive fall in energy prices.
It doesn’t look to be the case.
That’s a big element. The prices have certainly fallen very dramatically.
Yeah.
So other risks, we have a higher interest rate environment now. We’ve had it for a while. We had some financial shocks this year.
Yeah, in March.
Not in the eurozone, in the US and in Switzerland, particularly. How confident are you at the ECB that the eurozone banks are good, healthy state to cope with what is, for their borrowers, a very different interest rate environment?
Well, first of all, I would observe that there has hardly been any spillover effects in March, when Silicon Valley Bank, First Republic, Signature went under. Credit Suisse did not affect either, in terms of financial stability, the euro area financial system and the banks.
Second, I think that the regulatory efforts that have been deployed for the last 13 years– I was looking at the Basel III initial project and the finalisation where we are now finally heading, I think the regulatory environment has had a lot to do with it, so the strengthening of tier one equity for the banks, the strengthening of their liquidity buffers, the macroprudential buffers that we used, including during the COVID period.
I think that has made the large systemic institution and the international systemic institutions much stronger. And I would also observe that in the last year or so, the circumstances have been favourable to them. And the profitability, the dividend decisions, bonus plans, in some countries, have demonstrated that they are faring quite well. Is that going to be long term exactly the same? Probably not.
And I know that banks, they are very attentive to that. The gap between their rising borrowing cost and the remuneration that they have to offer to their term depositors, in particular, is going to have an impact.
Of course.
The health of some of their loans is also going to be affected. The volume of lending that they give is going to change, also, the picture. So I think it was a good ’22, ’23. The future might be a little bit different. And they have to care for that. And they have to buffer for that.
Let’s move on to then another obvious risk, which is on the fiscal side. There have been lots of spending and quite large increases in debts, some of it, of course, managed within the EU as a whole. Interest rates are rising, interest rates long and short. And so the cost of government borrowing is going to rise.
Is this fiscal background– and obviously, 12 years ago, 10 years ago, 12 years ago, there was quite a lot of concern about fiscal divergence in the eurozone, created a crisis. Are you confident about and comfortable with the fiscal positions of the major member states, or the member states, and the manageability of government debt markets?
I’m uncomfortable about the fact that the fiscal framework has not yet been agreed. And I think that it’s critically–
–and quite revealing, I think.
What?
A noteworthy effect and quite revealing. It’s politically very difficult.
It is politically difficult. But if we don’t have what they call a fiscal governance framework, for lack of a better word and for avoiding the other acronyms from the past to identify a change, it’s critically important to have a framework within which member states operate. We don’t have a fiscal union. We have a monetary union.
But even for our own monetary policy, we need to understand within which parameters ministers of finance of the eurozone, 20 of them, are going to decide their budget and are going to manage their debt trajectory and are going to manage their fiscal position and reduce their deficit, for some of them, where it’s needed. So I’m not comfortable with that fiscal governance pact not having yet been agreed.
I was a little bit reassured yesterday after the Ecofin meeting of the 27 finance ministers. That made some little signals of Germany and France, eventually working hard together on reaching a platform that would be common to both of them. But it’s not just two countries. But we know that if those two countries work together, there’s a chance that it moves further and comes to a close, I hope, before the end of this year, in terms of agreement.
In this context and also with your own new mechanisms for handling fragility, essentially, you feel pretty comfortable that the public debt markets of the eurozone members will be reasonably stable?
One thing that I would mention, Martin, is that currently, the debt service is at around 1.7% of GDP, which is not significant–
That’s the average.
That’s the average. You’re quite right. And there are a few countries that have high debts because high-debt service is associated with high-debt countries quite often. But on average, we are at 1.7%. I think many countries and many treasuries, in particular, have taken advantage of the period of very low interest rates to extend the maturity of their debt. But it’s a fact that there will be refinancing coming up as redemptions come along.
And cost of financing will be increased. So we are in this fascinating race against time, where the calibration of our monetary policy has to be sustainable and subtle at the same time.
Do you expect to continue to be able, comfortably, to sell the bonds or at least some proportion of the bonds you own?
We have made decisions, in that respect. And under the asset purchase programme, we are letting the portfolio on a runoff basis. So we are not selling.
That’s right.
And no such decision has been either discussed, made, or is in the making. On the Pandemic Emergency Purchase Programme, for the moment, we are continuing to reinvest. And that discussion is to be had in the future, as to whether or not we move into a runoff mode and when it ends.
So I have three more questions and very little time.
OK.
So give a very crisp answer.
All right.
Should the ECB be doing more directly to support climate finance?
OK, this is my personal conviction–
Yes, of course.
–which has nothing to do with the position of the euro system, at large, and the ECB, at large. But my personal conviction is that, yes, to the extent that it serves our monetary policy with the mission to bring inflation back to 2% medium term, yes. That was crisp enough, wasn’t it?
Yes, that’s beautifully crisp. We’ll have time for a fourth question. Second, do you think there is a prospect for– a reasonable prospect– and a value in considering a digital euro for households?
Yes.
For the private sector.
Yes. That is super crisp.
Yes.
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Could you elaborate a little bit more about the conditions?
Yes, because when everything goes digital– I mean, you are digital, not you as a person, but the tools you use, the instrument that the Financial Times operates under. All of that is digital. And let alone artificial intelligence. But digital is part of our life.
So you have to ask yourself the question, why wouldn’t money be digital and associated with the sovereignty of a state or a region, which has one, single currency, so that currency being also digitally supported and associated with the sovereignty that comes with a currency? So I think that we have to go in that direction.
And if it is user-friendly, cheaper, and gives a guarantee of control over your payment system and your currency, why not? It would have benefits for consumers.
And is that a widely shared view in the Eurosystem?
It’s a view that is widely shared by the governing council because decision was made in mid-October to actually go forward and develop the project in, what will be, one of these coming days, a pilot-operated digital euro, which can then, if proven efficient and user-friendly and privacy protecting, will be launched on a larger scale. And I’d rather have a digital euro than be digitalized by somebody else outside the euro area.
I presume, at this stage, given what you said, you can’t give a timetable for this?
That’s correct. It has to be– I’ll tell you, it has to be right. So if it takes another six months more than what was anticipated, that’s OK because it has to be done right.
Last question. One of the big issues that has been hotly debated– and this is transatlantic– is the question of whether the Russian reserves, which have been sequestered, essentially, should be used in whole or in part to pay for the restructuring and reconstruction of Ukraine, which has been so horribly and brutally invaded. What is your view on that, as conceptually and practically, the pros and cons?
I think, Martin, we would need a little more than just one or two minutes on the topic. But suffice to say that, number one, it’s a decision that has to be made by member states. It’s an act of sovereignty. And it touches on the international order that has been established over the many, many, many decades. Number two, the ECB, like a few other central banks, has been instrumental in immobilising these assets.
What is done with it and what is done with the proceeds of these assets, which is a different question, is a matter that has to be properly dealt with by sovereign states in accordance with their legal system. But I think it’s unrelated to the moral imperative that we all have to make sure that Ukraine can reconstruct itself.
Well, we have, it appears, perhaps, a tiny bit longer.
Your pressing me for time. So I tried to–
I didn’t realise you would be so crisp. Can I just ask one final issue in that? In my conversation with Mario Draghi, which had covered many things, he talked a lot about his concern that the European economy was falling behind technologically, particularly not at just the US, but even China. Now, this is not a responsibility of the ECB. But is this a concern that you also share?
And do you feel that the eurozone– by the way, the EU also clearly includes the UK– are just not responding to this challenge adequately?
I think it is wonderful that someone of the intellectual calibre of Mario Draghi is focusing on these issues. And we will help him as much as we can if he requests some help from our economists. I think it requires to really go into sectorial analysis and in a very granular way to identify those areas where indeed Europe is lagging behind.
And it is a concern to us because it has to do with the productivity, which obviously has an impact on wages, on inflation, and on factors that we are attentive to. But there are sectors where we are lagging behind. You look at patents. You look at several indicators. But I would guard against anyone who jumps to, OK, well, in services, we are not so good. But in manufacturing, because of our great engineers, OK, we are still OK.
I think you need to really go deeply into sub-sectors and almost custom line item to see what is our competitiveness at the moment and how it can be improved over the course of time.
Even in some of the engineering sectors, for instance, automobiles.
For sure.
Digital economy is becoming a massive challenge.
Yeah, yeah, yeah.
So thank you very, very much. It’s been a wonderful discussion.
My pleasure. Yes, it has been.
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