ECB’s Mario Draghi on economic developments

In an interview yesterday [Oct 31] with newspaper Il Sole 24 Ore, ECB president Mario Draghi referred to key economic developments in Europe and internationally, whilst he did argued on Greece’s national debt. Key parts of the interview, based on a translation published on ECB website have as follows:

On international economy

“The conditions in the economies of the rest of the world have undoubtedly proved weaker compared with a few months ago, in particular in the emerging economies, with the exception of India. Global growth forecasts have been revised downwards. This slowdown is probably not temporary. To illustrate the importance of emerging markets, it is recalled that they are worth 60% of gross world product and that, since 2000, they have accounted for three-quarters of world growth. Half of euro area exports go to these markets. The risks are therefore certainly on the downside for both inflation and growth, also because of the potential slowdown in the United States, the causes of which we need to understand fully. The crisis led to a sharp drop in incomes. It is up to us to push them up again. This requires the necessary structural reforms to be carried out in order to increase labour force participation rates and boost productivity. There are still at least 20 million unemployed people in the euro area – many of whom are young – who need to be brought back into the labour market. This represents enormous potential.”

On inflation

“I would make a distinction between the forecasts for the next period and those for the medium to long term. As far as the next few months are concerned, the most relevant factor will be the price of energy. We expect inflation to remain close to zero, and maybe even to turn negative, at least until the start of 2016. After that, the effect of the sharp decline in oil prices that we have seen between the end of 2014 and the end of this year will disappear from the one-year ahead annual price index. This will lead to a purely mechanical increase in annual inflation.

From mid-2016 to the end of 2017, also due to the delayed effect of the depreciation in the exchange rate, we expect inflation to increase gradually. But what is important to note today is that, even in September’s forecasts, we had already lowered our inflation expectations for 2017 compared with those we forecast in March, when we had just started purchasing €60 billion of public sector securities a month.

It will therefore take longer than was foreseen in March to return to price stability. The good news about medium-term inflation expectations is that, after falling in September, these have now returned to a level above 1.7%, which is not far from our inflation objective. However, these figures should be viewed with caution, because these expectations have always showed a degree of volatility.”

On ECB intervention

“If we are convinced that our medium-term inflation target is at risk, we will take the necessary actions. In the meantime we are assessing whether the change in the underlying scenario is temporary or less so. Moreover, after the meeting in Malta, we asked all the relevant committees and ECB staff to prepare analyses of the relative effectiveness of the different options for the December meeting. We will decide on this basis. We will see whether a further stimulus is necessary. This is an open question. The programmes that we have put together are all characterised by their capacity to be used with the necessary flexibility.”

“Things have changed”

“The circumstances informing the decision to reduce the bank deposit rate to its current level actually consisted of a macroeconomic framework that has since changed. The price of oil and the exchange rate have changed. I would say that the global economic situation has changed. The interest rate on deposits could be one of the instruments that we use again. Now we have one more year of experience in this area: we have seen that the money markets adapted in a completely calm and smooth way to the new interest rate that we set a year ago; other countries have lowered their rate to much more negative levels than ours. The lower bound of the interest rate on deposits is a technical constraint and, as such, may be changed in line with circumstances. The main test of a central bank’s credibility is – as I have said before – the ability to achieve its objectives; it has nothing to do with the instruments.”

On QE effectiveness

“I would say that, overall, the Governing Council took steps based on the information available. As regards the policy design, this move towards QE started with a speech at the Sciences Po in Paris in March 2014, continued with one in Amsterdam in April of that year and finished in Jackson Hole in August. In particular, in Amsterdam it was said that a significant worsening of the medium-term outlook for inflation could warrant the purchase of government securities. As these conditions gradually materialised, we worked consistently on this plan.

On the whole, I would not say that we acted late: we took note of the information which became available and at the same time drew up the conceptual framework that led to these decisions. It should also be taken into account that, in the case of monetary union, the decisions were even more complex, because it was necessary to assess the relative importance of different factors driving the fall in inflation such as the structural readjustments in the countries which were in greater need of restoring their competitiveness, the fall in the price of oil and the strong appreciation of the exchange rate in 2013. I would say in short that what emerges from this experience is that the monetary policy framework which was reactive at the end of 2012 became proactive with the speeches I have mentioned.

On low inflation

“Low inflation has two effects. The first one is negative because it makes debt reduction more difficult. The second one is positive because it lowers interest rates on the debt itself. The path on which fiscal policy has to move is narrow, but it’s the only one available: on the one hand ensuring debt sustainability and on the other maintaining growth. If interest rate savings are used for current spending the risk increases that the debt becomes unsustainable when interest rates go up. Ideally, the savings are instead spent on public investments whose rates of return permit repayment of the interest when it rises. Growth is maintained today and future public finances are not destabilised when rates go up.

Obviously it’s not simple because, as we know, there aren’t many public investments with a high rate of return.”

On structural reforms and low interest rates

“Structural reforms and low interest rates complement each other: carrying out structural reforms means paying a price now in order to obtain a benefit tomorrow; low interest rates substantially reduce the price that has to be paid today. There is, if anything, a relationship of complementarity. There are also other more specific reasons: low interest rates ensure that investment, the benefits from investment and from employment, materialise more quickly. Structural reforms reduce uncertainty regarding macroeconomic and microeconomic prospects. Therefore, it is the opposite, rather than seeing an increase in moral hazard, I see a relationship of complementarity, of incentive. But it should never get to the point of having to consolidate the government budget when market conditions have become hopeless. Experience over recent years has shown that, in these circumstances, governments often make mistakes in designing economic policies, dramatically hike taxes and reduce public investment, without significantly reducing current spending, and postpone the structural reforms that require social consensus. In this way, they exacerbate the recessionary effects of the high interest rates and slow the fall of the debt-to-GDP ratio.

To conclude, in the euro area the markets do not typically influence the propensity of governments to carry out structural reforms; when this happens, because the governments have delayed the reforms for too long, and owing to the deterioration in the general conditions, the resulting economic policy action does not foster growth.”

On Greece

“Fundamentally, trust has been rebuilt, primarily by the Greek government, which today is in talks with the European institutions in an atmosphere of close collaboration. The bank recapitalisation process will commence shortly, as soon as the aspects of our assessment have been published. Therefore, I do not believe that there is still a background of mistrust. This was certainly another severe test that monetary union has nevertheless been able to face and overcome. It is too early to draw conclusions, but if we compare the current dialogue with the Greek government with how it was five or six months ago, we see an enormous difference.

Greek debt is sustainable if, first, the government complies with the obligations under the programme that it has agreed to, taking responsibility for or ownership of the programme. Second, for the debt to be sustainable a certain degree of relief is required; the latter should be such as to remove any doubt as to the future sustainability of the debt itself, once the first condition has been met. What type of “debt relief” to provide and how to calibrate it so that incentives for compliance with the programme are not distorted are decisions for the Member States, namely for those whose balance sheets will be affected by the decision. The ECB has nothing to say in this regard.”

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