Q&A at UBS event
Transcript of Q&A session following a fireside chat with Yves Mersch, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, at an online UBS event on the European economic and policy outlook, conducted on 30 October 2020
4 November 2020
President Lagarde stressed in yesterday's decision that there had been unanimity in the analysis, and also in the need to take action. But, of course, no action was taken yesterday, and so it wasn't entirely clear to me what exactly there was unanimity on. And also, given the pre-announcement, isn't there a risk of raising expectations too much and underwhelming them in the end?
There was unanimity insofar as everyone agreed that we are facing high uncertainty. Looking backwards we were quite confident that all the measures taken, not only on the monetary policy side but also on the fiscal side, at the national level, at the European level and on the regulatory side, were showing strong effects. We will see an uptick in economic activity in the third quarter, maybe even going into double-digits. And so looking backwards we have reasons to be satisfied with the performance of the different policymakers.
However, looking forward, the situation has suddenly taken a turn for the worse, even if in our baseline it was already foreseen that there would be a second wave. A second wave was firmly part of our forecast, but what is new is the extent of the deterioration. Now, the reaction of the different governments to this second wave has been quite different from the generalized lockdowns that we experienced during the first wave. And therefore, before we can see what the economic consequences of this second wave are, we need to take into account the scope of the shutdowns that are being engineered in the different countries.
But we also need to take into account the additional fiscal support that is being discussed and decided upon every day in the member states. Before having clear indications on the direction and the consequences of this second wave, it would have been surprising to be able to properly design and engineer a monetary policy response. But we signaled that we are ready to to look at our toolbox, to recalibrate or to rectify or to adjust – whatever term you want to use – all our instruments in order to take into account the new situation. And we are all in agreement that in the new situation we need to recalibrate what we have been doing, and recalibration also means assessing the efficiency of the instruments in the new circumstances.
So in terms of the effectiveness of the policy response so far, which of the tools that the ECB has deployed do you think have been most effective? And which instruments you see mostly likely to be used going forward?
In order to measure effectiveness, you have to be in agreement what you are talking about. We acted on two fronts: One was providing a backstop. We had market turbulence which we needed to bring to a halt with a sufficient amount of liquidity. From that point of view, I think both our pandemic emergency purchase programme, PEPP, and above all our liquidity provisioning instruments, PELTRO and TLTRO, were quite effective in providing the necessary liquidity to the different markets. I think this backstop has been extremely effective.
But we also have the asset purchases both under the regular programme, which has been continuing, and the new programme with an increased amount of flexibility allowing us to be much more surgical and to maintain the monetary transmission mechanism throughout the euro area. And that was also a signal for our monetary policy stance overall, where the PEPP has been supportive too. So looking backwards, I think there is agreement in the Governing Council, I would say unanimous agreement, that in the first wave the reaction of monetary policy was highly efficient and effective.
Now, of course, we are entering a new phase. The reaction is different this time, and we have to take into account the reaction on the fiscal side. There is probably a need for more fiscal action in these circumstances since it is not for monetary policy to extend credit to individual companies. That is a fiscal task, and we have encouraged the fiscal side to expand this intervention in view of the challenges that we are facing in Europe.
Your Governing Council colleague Robert Holzmann this morning said that the ECB may think of new instruments by December. Coming from a person who is seen as very much on the hawkish side of the spectrum, I guess people took note of that. What is your view in terms of things that haven't been tried yet like purchasing bank bonds, bank loans, or even equity ETFs. Is it the time to get more creative?
In my opinion it's certainly not the time to launch an auction of who says more and who goes further. We'll do an examination within the existing framework of the committees of the ESCB, the European System of Central Banks. And we will assess the existing instruments that are already operating. We will see to what extent each of these instruments are considered to be efficient, and especially marginally efficient, because some of these instruments have been there for a prolonged time. And there might also be a discussion whether their marginal efficiency may be waning over time. And this has to be discussed.
We also have to be very open to discuss potential negative effects or secondary effects that might accompany some of these instruments. And as always we have to be legally sound. That means we have to look at our instruments in order to assess whether they are 1) necessary, 2) appropriate, and 3) proportionate. This work will be done in the coming weeks, also on the basis of the fiscal response in the different member states. And let me add another element. It is also important that the confidence boost from the European action is being extended by a rapid implementation of the decisions that have been taken at the highest level in the European Council. We cannot be losing time now.
The other thing that has been much talked about following yesterday's ECB communication is rate cuts. We have now almost four basis points of cuts priced for December, and for next year about 12 basis points. Do you see a scenario where yet deeper negative rates would make sense?
We have always said that the primary instrument of a central bank are interest rates, and that we still have this instrument available. But at the same time – as I have just said – we also have to assess potential negative effects. And we have also to assess efficiency, not only short-term but also medium-term, because for some of the instruments there are quality effects insofar as negative rates would have to be extended to the retail sector. This would obviously be a very uphill struggle in terms of defending the reputation and confidence with European citizens. All this has to be factored into our discussion. So nothing is ruled out, but nothing is a given.
In terms of asset purchases, conceptually there's a difference between PEPP, which is an emergency pandemic program, and regular asset purchases. If there was a decision to buy more assets, is it obvious that that would still be under the pandemic program? Or if the monetary stance needs to be made more accommodative should it be regular asset purchases?
This will without any doubt be part of our discussions. What is the most appropriate response and what are the most appropriate instruments under present circumstances. To some extent that depends also on the forcefulness of the new fiscal measures that are being decided and implemented. And it depends on the time axis. This pandemic will probably be a little bit longer with us than had been foreseen. That obviously would then have to be reflected in the timeline of the instruments.
So one possibility is the extension on the time axis of some of the instruments. The other is an increase in pace and scope. And then you can have tweaks. You can make the instruments more surgical and more targeted. So all of our instruments will be under examination. Rather than a step-by-step approach, we decided to have a comprehensive answer at our next monetary policy meeting.
Yields and peripheral spreads are close to records lows, does that mean that further asset purchases actually aren't that powerful anymore, and maybe not the right instrument given that the market may have gone as far as it can?
Well, most of the asset purchases have taken place in the sovereign sector and there is a huge amount of new debt coming forward. So if you maintain your existing fire power that would mean that in relative terms it might diminish compared to the overall economy. So all these factors will have to be weighted in terms of their efficiency. I also think that we will have a discussion on the need of using the flexibility associated with some of our emergency instruments compared to our normal unconventional instruments, like for example, the Asset Purchase Program (APP) compared to the Pandemic Emergency Purchase Program (PEPP) which allows increased flexibility in terms of the assets we buy, the scope and the jurisdictions.
We do not seem to have such a big issue anymore with the monetary policy transmission mechanism.Thishas allowed us to allocate our purchases much closer to our benchmark, the capital key. So all of this will again be discussed to see what is the most appropriate way to address the weaknesses in our economies. And for the moment, fiscal policy seems most appropriate because of the issues on the demand side, of consumers being affected. These are issues which are much better addressed by direct fiscal policy, especially also if there is an increase in unemployment.
Just one more question on asset purchases, and specifically the legal situation: There's always a lot of debate among investors regarding self-imposed constraints. We see the Bank of England, for example, apparently feeling comfortable buying up to 70% of any issues while the ECB has put a much more narrow 33% limit on itself. Could these limits be pushed higher?
We are bound not by self-imposed limits but by red lines which are of a constitutional nature and which are in the treaty. The self-imposed limits only serve to respect those constitutional limits, which are not at our disposal. The European Court of Justice has reconfirmed that if we enjoy a broad degree of discretion, this discretion must be exercised in a way that allows continued judicial scrutiny of what we are doing. Otherwise, discretion is at risk of becoming arbitrary. We therefore always have to establish a framework that is publicly available and allows judicial scrutiny. That is the reason why we have what some people call self-imposed constraints. And the 33% limit has to do with the fact that we do not want to be involved in a potential debt restructuring.
You compare us to the UK, but the Bank of England buys government debt, not local debt. I don't know any other jurisdiction which uses local debt. I think in Switzerland the SNB would not buy cantonal debt. In the US, the Fed does not buy state debt, they buy federal debt. That is why we are buying a much higher percentage of what we call the supras, the supranational debt of European institutions. The Pandemic Emergency Purchase Programme has disenfranchised itself of some of these constraints in response to the consequences of the pandemic. But it still keeps a certain amount of constraints, like for example the benchmark of the capital key. And this remains part of our programme and of our framework. We are committed to this framework because in a democracy we are subject to judicial scrutiny and the rule of law.
In Europe, most of the funding of the economy is done via the banking system, unlike in the US for example. But broadly speaking the European banking system is in a weak state. What could the ECB do to further help the banks? This week your colleague Andrea Enria, the head of the ECB Supervisory Board, argued for a bad bank as a potential solution?
We are very much focused on having the banking system continue its intermediation and capital allocation role to the most productive parts of the economy. The banks also have to take the decision which parts of the economy are beyond what is considered viable. This is not something that should be exercised by the public sector, because that is not a part of a functioning market economy, which again is a constitutional obligation for us.
Banks by nature are to some extent pro-cyclical, and that is exactly the reason why in the first wave of the pandemic we flooded the whole system with an enormous amount of liquidity to maintain the credit flow to the economy. This was extremely efficient as the amount of credit to the economy, according to the latest statistics, still stood at 7% of GDP in September. But it is inevitable that if you have an economic slowdown there will be a deterioration of asset quality and an increase of NPLs. Part of this has been attenuated and mitigated by moratoria and public guarantees. And that is why we have not seen such the surge of non-performing loans as in the financial crisis of 2008-2012. But there will inevitably be a deterioration of asset quality.
We have also provided the banks with regulatory and operational relief. And those measures, all in all, have been equivalent to more than three times the total profits that were paid out by European banks in the last year before the pandemic. So there have been many measures on the regulatory and supervisory side, and on the monetary side, to have the banks continue providing liquidity and credit to the economy. We have to see whether some of the fiscal measures – moratoria and public guarantees – will be prolonged. In some countries, they were supposed to slow down or come to an end this year. In other countries they have already been extended until the middle of next year. So we have to see in the coming weeks what the European response will be as that will have an immediate effect on the banking system. We want to avoid a financial amplification of real economy issues.
There are always proposals how we could take the next step before the previous step has been accomplished. And for me, the most important step is to accomplish the banking union and to have a deposit guarantee scheme throughout the banking union. For me that is a precondition for considering anything like an asset management company. A second issue that has to be discussed in relation to this proposal is whether we see a market failure. If so, governments have to step in. And then a third element, according to the treaties – again, I’m always going back to the treaties – is that what can be done at the national level should be done at the national level. Why transfer onto the European level problems that originate at the national level?
Once we have not only a single supervisor, but also a common deposit insurance scheme, a common resolution scheme, and a capital markets union, an asset management company for cross-border banks' assets would also make sense. But we have a long way to go. And maybe as a first step we could start with having a common database - that would already be very helpful.
If the ECB saw bank lending getting worse, how would you further incentivize the banks to take up even more TLTRO funds, how low and how long would you be prepared to go with negative rates that the banks can benefit from?
Again, we should always weigh the very short-term benefits with the medium/long-term costs. And if we forced the banks to twist their risk assessment in order to increase bad loans on their balance sheet, we would risk to alleviate the real economy problems. There would be financial amplification of economic problems in the medium and long-term. We have to make sure that the financial intermediation system is safe and resilient. That is the task of the supervisor and its regulation.
Monetary policy can make sure that there is no shortcoming of either collateral or liquidity available for banks to continue to support viable borrowers. But we will not force the banks to willfully deteriorate their balance sheets. We have written to the banks recently that they must not be in a situation where they don’t know anymore whether the loans are not being repaid because of moratoria or because of deteriorating underlying credit quality of the borrower. In the latter case, such loans have to be reclassified as unlikely to be repaid once the moratoria come to an end. It's very important that the banks continue to make a proper assessment of the credit worthiness of their borrowers and debtors. They must continue to remain in close contact with and monitor their clients in order to avoid a loss of visibility of the quality of their future assets.
One specific question is on the dividend ban. What can you tell us about potential future scenarios in terms of a Fed model, payout cap, delay, catchup?
Let me say first that a dividend ban is a blanket instrument. It's an exceptional measure that has to remain temporary. Having said that, if you receive public money then it is not to pay out private shareholders. Now there are different possibilities to arrange things. The Swiss have found quite an interesting way to try and accommodate both objectives. We have done it differently, and we have many people taking a very keen interest, from the European Parliament to the ESRB. When the pandemic stroke, the lockdowns imposed were very general and across the board. The dividend ban was also general and across the board.
This time around in the second wave, we see that the reactions are much more targeted, even surgical. I think there are arguments to remain very conservative as to the principle of dividend distribution, avoiding public support being privatized and paid out to private shareholders. But there are also situations which would warrant a return to more normal. If for example the capital available and the distance to the maximum distributable amount was very big, a certain amount could be resumed for dividend payouts. But this is a discussion that has to be continued.
We will not take a decision until we have further evidence from the economic fallout of the second wave, like for monetary policy. That is the reason why we will only have this discussion in mid-December when we have the renewed certainty of what is the economic fallout, and also what is the quality of capital planning of the banks. And if there is the same amount of uncertainty, that will of course not encourage us to revert too rapidly to what I would call the normal situation. But as always in life, we will probably have to follow a middle way, taking into account what is the evolution of the world around us and employ our instruments accordingly.
One more question on the exchange rate side: if currency strength was a problem, how would you look at asset purchases versus further rate cuts? Do you see a difference in terms of exchange rate impact, and could this play a role?
From a purely analytical point of view, you will have seen the studies which make the distinction between the different instruments. But we do not design our instruments to target exchange rates. Our objective is price stability over the medium term. Exchange rates do not drive the design of our instruments, but they are an element that we continue to monitor because it influences other variables which are very important for our price stability objective. I would call it a secondary effect.
Looking a little bit further out towards the strategic review: how much inspiration do you take from the Fed in terms of their change of the strategic framework, and is average inflation targeting something that you could see for the ECB as well?
The Fed has different objectives and operates in a different structural environment of the economy than is the case in Europe. We are a much more bank-financed economy, and capital markets play a lesser role. We also do not have a dual objective, we have a single priority. That is what is driving us. We of course take note of the Fed's adjustment, but we will follow what we have in our constitution, our objective. We have to obey the treaty and our statutes.
And we also want to be understood by our citizens. It's not about changing the objective every couple of weeks, months, or years. We want to be connected to our citizens and be connected to an understanding of the citizens of what we are doing. And I think this has been achieved. We have been able to keep inflation expectations anchored. Even though expectations have come down a little bit, we are still – at least with long-term expectations – very well anchored. And we do not see signs of disanchoring. And that begs the question as to the changes that we want to do. Why would we go for an attitude of make-up? If you have 20 years of below target, does that mean you need 20 years above target? I think that would be very dangerous for inflation expectations.