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European Central Bank Director Isabel Schnabel interview

ECB Director Isabel Schnabel interview: "We need to keep raising interest rates"

She is the top German at the head of the central bank: In an interview, ECB Director Isabel Schnabel explains why inflation will not fall significantly again until 2024. / Isabel Schnabel interview

Inflation in the euro zone is higher than ever before, and prices are also rising rapidly in Germany: everything in August was 7.9 percent more expensive than in the same month last year.

Many people are therefore turning their attention to the European Central Bank (ECB). It is it that is actually supposed to ensure stable prices – but recently it has been lagging behind the rising inflation rate and even with a sharp increase in interest rates it has hardly been able to push inflation down to the desired level of two percent per year.

One of the most important women who has a say in the monetary policy course of the central bank is Isabel Schnabel. The economist is the only German member of the Executive Board of the ECB. t-online met her in Frankfurt’s ECB tower for an interview. A conversation about interest rates, failure and the looming economic downturn in Germany.

t-online: Ms. Schnabel, you come from Dortmund, a city of workers and laborers. Given the high inflation, how often do you think of these people?

Isabel Schnabel: Many people worry that they can no longer pay their heating bills. Even groceries become scarce for some at the end of the month because prices are rising so much. That concerns me a lot. The ECB is responsible for price stability in the euro area. Our task is to ensure that inflation is kept at 2% per year over the medium term. At the moment we are far from our target, inflation is far too high.

In Germany, the inflation rate was 7.9 percent in August. Will we ever come down from this level?

Yes, but unfortunately not immediately. Inflation is currently being driven primarily by the sharp rise in energy prices. Added to this are the disrupted supply chains caused by the pandemic, which also make many things more expensive. And we see sharply rising food prices on the world market. With our monetary policy, we have little direct influence on what happens on the world markets.

Isabel Schnabel interview / Why?

The monetary policy of the ECB influences inflation primarily through demand. When interest rates rise, borrowing becomes more expensive and it pays to save more. This dampens demand for products – both from consumers, who then spend less, and from companies, who invest less. The companies can then no longer raise their prices as quickly because fewer people want their goods. So inflation goes down. But that takes time.

How much longer?

Probably for quite a while. In the short term, inflation could continue to rise despite the recent rate hikes.

And when will it fall again?

In our forecast models, it will take until 2024 for inflation to level off again at the desired level of two percent.

That means you’re still missing your inflation target for more than a year. Have you failed?

As I said, a large part of inflation is due to factors that we cannot influence directly. The development is reinforced by the war in Ukraine, which on the one hand has worsened the economic situation and on the other hand continues to drive up inflation. But as early as December last year we began to tighten monetary policy step by step.

We have initially stopped buying additional government bonds. We have raised interest rates sharply twice since July, putting negative and zero interest rates behind us. At the beginning of September we even raised interest rates by 0.75 percentage points. In doing so, we have sent a strong signal: we are doing whatever it takes to bring inflation back to our 2% target.

Much too late, critics counter.

In anticipation of our actions, interest rates on the financial markets rose much earlier, and at a very rapid pace. You must also consider that we have been in an environment of tremendous uncertainty since the beginning of the pandemic. When the Omicron wave started rolling last winter, we didn’t know if full-scale lockdowns were imminent again. In spring it was not foreseeable how the war would affect economic development and inflation. From the point of view of the Central Bank Council of the ECB, the steps taken were appropriate at the time to achieve our inflation target in the medium term.

There were certainly economists who warned of higher inflation as early as the spring. Why were the ECB experts so wrong?

In retrospect, one can discuss whether we shouldn’t have acted a little earlier. But now the turnaround in interest rates has started. We are on the right path.

The latest rate hike was the largest in the history of the ECB. Some fear that this could stall the economy. Which is Worse: Inflation or Recession?

The ECB has a clear mandate – and that means price stability. The signal we sent with the latest rate hike is clear: we are taking decisive action against inflation and making sure that inflation levels off again at two percent per year over the medium term.

So economic development doesn’t play a role for you?

A looming downturn would dampen inflation. Of course, we take this into account when making our interest rate decisions. However, the starting level of interest rates is very low. It is therefore clear that we must continue to raise interest rates.

Will that already happen at the next Governing Council meeting at the end of October?

I assume that the ECB Governing Council will hike interest rates further at its next meeting. At the moment, I cannot say how large this interest rate hike will be and up to what level we will raise interest rates. We drive on sight and reassess the economic and inflation data before each meeting.

The Ifo Institute expects a “winter recession” for Germany. They also?

For the euro zone as a whole, we are currently not assuming a recession, but rather a stagnating economy. The situation in Germany is unfortunately worse. Germany has been particularly hard hit due to its heavy reliance on Russian gas. A recession may be unavoidable here.

Will there also be mass layoffs?

The labor market has proven to be very robust so far. The unemployment rate in the euro zone is historically low, and there is even a labor shortage in many countries, including Germany. Many companies have an interest in keeping their employees despite the difficult business situation.

Does that mean it might not be that bad after all?

Most people will hopefully keep their jobs. Despite this, people are feeling the effects of high prices, especially those on low incomes. Because wages are not keeping pace with the rise in prices.

This, in turn, is likely to cause high inflation to become entrenched in many people’s minds. How concerned are you?

Inflation expectations play a very important role in our decisions. We are concerned that more people are now expecting inflation to be above our two percent target, even in the medium term. It is therefore all the more important to send clear signals that people can rely on the ECB and that inflation will fall again.

And why should people believe you now?

Because the ECB has repeatedly shown in the past that it reacts appropriately to developments in the economy. We acted decisively in times of low inflation and also during the Corona pandemic made a significant contribution to Europe getting through this severe economic crisis in good shape. We have thus shown that the central bank can be relied on. People can trust us. We will do our job and ensure stable prices.

What happens if that doesn’t work – and people still expect permanently higher inflation rates?

One danger is the emergence of a wage-price spiral. If, against the background of rising inflation expectations, workers demand very high wage increases and companies then pass these on through even higher prices, wages and prices can push each other up. However, we do not currently see any indications of this. Wage growth has picked up but is still moderate.

Indeed? The IG Metall trade union alone is calling for an enormous increase in wages of 8.2 percent in the current wage round.

So far, wage settlements are nowhere near keeping pace with inflation. Adjusted for prices, wages are falling – and with them purchasing power.

So if employees and employers agree on a decent plus just once, doesn’t that automatically drive up inflation?

What we need to avoid is that the expectation of persistently high inflation becomes entrenched. We are therefore closely monitoring the dynamics of wage developments.

The governments of Europe are currently trying to relieve their citizens by many means. Can this compensate for the loss of prosperity?

Higher energy prices are making Europe poorer. We need to send a larger proportion of our income abroad for energy imports. The state cannot change that in the short term. However, he can cushion particular hardships and set the course for the future. To this end, politicians should not ignore the steering effects of prices.

Higher energy prices ultimately help to become less dependent on fossil fuels and thus to achieve the climate goals that have been set. Investments are also necessary to accelerate the expansion of renewable energies. When it comes to government bailout packages, it’s important to be careful that they don’t fuel inflation even further.

As the? / Isabel Schnabel interview

If governments relieve the broad masses of the population, this can stimulate demand and further increase inflation. Then we might have to raise interest rates even more. From a political point of view, it may be advantageous to favor a large part of the electorate with a relief package. Nevertheless, we should always keep in mind: In the long term, these costs must be shared.

Where are you noticing that yourself?

I myself am able to deal with the current situation. Of course, people with higher incomes and assets are also getting poorer. But you can buffer it with your own savings.

And how do you restrict yourself in your everyday life?

Above all, I try to reduce my energy consumption. Not only to save money, but also for ecological reasons.

Finally, let’s look to Italy, where the EU-critical candidate Giorgia Meloni from the right-wing party Fratelli d’Italia could become prime minister on Sunday. How concerned are you?

As a rule, we do not comment on political developments in individual countries. The ECB is independent and makes monetary policy for the entire euro area. That’s why we’re orienting ourselves towards inflation in the euro area, even if the situation differs from country to country, of course.

The level of national debt is also different. Italy has very high interest rates and will suffer accordingly from a rise in interest rates in the future.

When it comes to government debt, the basic rule is: How well a country can bear the interest burden depends crucially on how strongly its economy is growing. This means that the countries must get on a sustainable growth path. The European rescue program “Next Generation EU”, which dates back to the pandemic, plays a major role. It is very important that the growth projects that are financed with it are consistently continued and actually implemented. That is the task of national politics. But we’re all in the same boat. It is therefore important to develop joint solutions at European level in order to overcome the current crisis.

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