Interview with Christine Lagarde, President of the ECB, conducted by Marie-Pierre Gröndahl on 2 October 2023
8 October 2023
The ECB raised its key interest rates for the tenth consecutive time in fourteen months, bringing the rate on the deposit facility to 4%, its highest level since the launch of the euro. Coming at a time when people are concerned about the level of interest rates, was this move justified?
We first need to put the action taken by the European Central Bank into context. For several years now the world has been facing a “permacrisis”, a constant succession of serious and unprecedented crises − in terms of their scale, their impact and the speed at which they emerged. The health crisis was followed by Russia’s unjustified war in Ukraine, and then by an acceleration in inflation. All this against the backdrop of the energy crisis, with a number of EU countries experiencing difficulties in some interest rate-sensitive sectors, including real estate. The ECB’s mandate, unchanged for 25 years, is price stability. It’s our compass. The key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.
Do you have the tools you need to fight inflation?
Our models were not perfectly suited to the nature of these crises, which resulted, among other things, in the complete shutdown of part of the economy during the health crisis, leading to a greater role for governments, which suddenly became protective. They were also not perfectly suited to the consequences of a war at the heart of Europe for the first time in decades, or to an energy crisis which sparked a sudden rise in inflation. The macroeconomic models used by central banks and other institutions were neither able to properly capture these kinds of uncertainties nor factor them into inflation and growth projections. We have worked on these issues, and we are continuing to do so, in order to make the projections more robust.
Have the past projection errors dented trust in the ECB’s actions?
And what are these reasons?
The errors were largely caused by the sharp rise in energy prices. Growth has declined across all economies – in advanced, emerging and developing countries. And there was an exceptional rise in inflation around the world, apart from in China. A very worrying situation, resulting in an inflation rate of 10.6% in October 2022, more than twice as high as its current level of 4.3%. That means that within one year, the efforts made – along with base effects, i.e. energy prices being much lower today than one year ago – have slowed the pace of inflation.
But that’s not the general feeling in Europe…
It’s hard to explain that the rise in prices is slowing down. Inflation persists, but it is abating and even steadily declining. That’s good news. I think our efforts have played a part in this, as have some of the economic policies pursued in Europe. At the same time, growth is weakening, which is why the International Monetary Fund has revised down its growth projections worldwide, except for the United States.
Why this gap with Europe?
Growth is falling in Europe. Is there a risk of recession?
We have revised down our growth projections to 0.7% in 2023, 1% in 2024 and 1.5% in 2025. The rate for 2025 is only slightly below the potential growth of the euro area. In Europe, we have devised a response and deployed unprecedented defensive measures that would have been unimaginable just three years ago, notably thanks to the Next Generation EU programme. Structural reforms are being put in place. And, just one year ago, who would have thought that we would succeed in replenishing more than 90% of our gas reserves by September 2023? This allows us to look towards the coming winter, if not calmly, then at least with a lot more confidence.
The German economy, the largest in the euro area, is slowing down sharply. What impact will this have?
This is one of the factors that is indeed weighing on the outlook for European growth. Germany had built its economic model on very cheap energy supplies and on export opportunities, especially to China. The ongoing adjustment in the German economy is affecting the growth outlook.
Does that complicate the ECB’s mission?
First and foremost, the ECB has to answer the question of how to provide price stability for economic actors across the entire euro area. To this end, we use tools that measure average inflation in the euro area, as well as underlying inflation – excluding energy and food.
In France, people are acutely aware of inflation. Why is that?
High and persistent inflation affects people’s purchasing power. But overall, while inflation in France is currently slightly above the European average, for a long time it was much less elevated than elsewhere in Europe.
Is this also due to the rise in interest rates?
Not exclusively. The ECB rates are the same for France as for all euro area countries. We have raised rates because this is the most efficient and effective tool that currently enables us to bring inflation down and ensure price stability.
Doesn’t this threaten growth?
Our mandate is price stability, and interest rates are our tool. We raise rates to make the financing of economic activity more expensive in a manner that dampens demand, and to thus bring about an adjustment between supply and demand, notably through reduced investment and consumption. The goal is obviously not to create a recession, but it does involve enabling this readjustment to reduce inflation and, above all, prevent a dangerous inflationary spiral. We must avoid this at all costs. We want to get inflation back to 2%, and we will achieve that.
Is there a risk of a wage-price spiral?
We aren’t seeing that for the moment, but we are monitoring it closely. Wage growth is expected to be around 5.3% in the euro area in 2023, and that figure is projected to be 4.3% in 2024 and 3.8% in 2025. This is consistent with inflation rates returning to 2% over the coming years.
Is the housing crisis that is picking up pace in France and Germany collateral damage from monetary policy?
The ECB sets the key interest rates in view of its price stability mandate. The housing sector is indeed sensitive to interest rates. But for many of the problems, all authorities need to get around the table and think about the stock of housing supply, and about social housing in particular. The fact remains that the major risk would be if people get into debt without having adequate means and are then confronted with repayment deadlines they cannot meet.
Is the ECB pessimistic about the short-term economic outlook?
There are three reasons why we are not pessimistic. We expect growth figures to increase next year. Inflation is currently falling significantly. And the employment rate is higher than it’s ever been in Europe, and it’s stabilising at that level. The big question right now concerns businesses. Will they accept absorbing part of the salary increases that will be negotiated this year and next in their margins – which didn’t change much in 2022? This is a key question. In our economic projections, we assume that businesses will behave as they have done during previous crises, in that they will reduce their margins a little in order to absorb part of the salary increases. The fall in demand should point them in that direction. It’s in their interest to do so, as public opinion will put them under pressure, as will the public authorities. The second element that is very important is energy prices. I think we have to get used to the idea that oil prices will remain high. This should spur us to pursue the fight against climate change even more vigorously, and to shift towards an energy mix that is less dependent on fossil fuels and foreign suppliers.
Anxiety is growing in European society in the face of a number of measures taken to fight climate change. How should we react?
We cannot wait. Combating climate change is imperative – we should all be hammering that message home. Everyone needs to realise it’s an emergency. We will only achieve this energy transition if we have everyone’s support, and with distributive policies that don’t worsen inequality. We cannot allow the energy transition to fail. Nor can we allow the consequences of climate change to become long-lasting. That is not an option. We have to find the fiscal and social means to make it as painless as possible for everyone, and for the most vulnerable in particular. A collective approach is needed. If there is any area where Europeans should borrow collectively, invest and share the burden as equally as possible, it’s the fight against climate change.
What will follow the current version of the Stability and Growth Pact?
I hope the European Heads of State or Government and the finance ministers will reach an agreement before the end of the year. The sooner there is an agreement on a reformed fiscal framework, the earlier we have clarity on the path of fiscal policies going forward.
