Frankfurt The European Central Bank (ECB) has set itself small-scale goals – and itself under pressure, says its former chief economist Otmar Issing. In an interview with the Handelsblatt he talks about the risk of accelerating deflation, the sustainability of bond purchases and why the ECB has maneuvered into a communication trap.
Mr Issing, the ECB and the Fed are turning to generous monetary policy. Is that justified?
We had a long boom in the US and in Europe. Now weakening is showing up, especially in Europe. There are also risks such as the trade war and Brexit. But for me that is no reason for monetary policy countermeasures at the present time.
Why are central banks reacting so eagerly?
Because they are less willing to accept the risk of even small setbacks, and therefore prone to hectic activism.
The ECB says that its 1.6 percent inflation is not enough. What is that supposed to mean?
The ECB is committed to price stability. At my suggestion in 1998, this was defined as inflation below two percent. 2003 was the addition, this should come close to as close as possible to two percent. But monetary policy can not control prices so precisely.
Why then the addition?
This is considered as protection against deflation, that is a slippage into sharply falling prices. For example, in the Great Depression of 1929, German wholesale prices fell by no less than 35 percent in two years. Such an event is an economic GAU. But the risk of accelerating deflation is nowhere to be seen anywhere in the world.
Why is only 1.6 percent inflation dangerous?
The ECB has maneuvered itself into a communication trap. If she announces that she wants to bring inflation up to two percent as quickly as possible, but does not reach that goal, she stands like a failure. On the other hand, as a former central banker, I would like to point out that ten years of recovery and inflation at 1.6 percent mean that we are almost on an island of the blessed.
The ECB wants to use even more funds. But will they work too?
The scope of the central banks has become very tight. In addition, the effect of, for example, the bond purchases wears off. It's like taking an antibiotic every time you have a cold.
In Europe, we have negative interest rates and it may even go deeper. Harm those of our economy?
Negative side effects such as life insurance and pension funds were mentioned when negative interest rates were introduced. In addition, in this world of low interest rates, the pursuit of returns reduces the risk premiums. This imbalance can turn into a sharp correction in the event of a crisis.
What do you think of staggered negative interest rates on bank deposits at the ECB?
This seems to me like a desperate attempt to mitigate the damage to the banks. But that's not really the solution.
The trend towards low interest rates can be observed worldwide. Are external reasons, such as the aging of the population, crucial? Or have the central banks created this trend themselves?
The discussion here revolves around the real neutral interest, that is the interest minus the inflation, where the economy is in equilibrium. Unfortunately, nobody knows this interest. There is some evidence that he has sunk. But central banks are helping to keep artificially weak banks and businesses alive with low interest rates. This depresses productivity and thus also the equilibrium interest rate. There are a number of studies, such as those of the OECD, which show a significant proportion of such economic "zombies" in some countries.
Because the ECB is running out of funds, more and more economists are demanding that Germany in particular should make more debt to support the economy.
The demands have been around for some time, for example from the International Monetary Fund. Then, with regard to old bridges and rails, we should invest more in the infrastructure to reduce the surplus in the current account. But whether that would work as hoped is uncertain.
But deficits could generally support the economy.
Germany has almost full employment and is experiencing an extremely expansionary monetary policy, combined with a weak exchange rate. I do not know any textbook recommending additional government deficits for this case. However, this does not preclude giving higher priority to infrastructure or education and research funding.
Recently, weaknesses have shown.
Yes, in industry, for example in the automotive sector, things are looking pretty bleak. But that does not speak in favor of countering fiscal policy.
In the case of a weak economy, consistent government spending and, for example, unemployment insurance act as automatic stabilizers. But without a deficit, that would probably not go away because of lower tax revenues. And then comes the topic debt brake in between. Is she obsolete?
The debt brake affects structural deficits, not automatic stabilizers. After all, it was anchored in the Basic Law, was previously irrelevant, and now they want to abolish it again.
But the government reaffirms the "black zero": no deficit.
There is a lot of rhetoric here. If one includes future burdens of the pension insurance or by the coal exit, the German financial policy is anything but very well there.
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