Europe ‘heading for transfer union’

David Marsh speaks to Handelsblatt

In an interview with Handelsblatt, OMFIF Chairman David Marsh warns that the European Central Bank’s temporary pandemic programmes may become permanent. This could lead to the creation of a ‘transfer union’, jeopardising euro area cohesion. The crisis is a danger to central bank independence, and politicians may use inflation to lower debt.

Claudia Scholz: European Union finance ministers disagree on when the time has come to cut back on expansionary financial and monetary policy. Most of them do not think the time is ripe. What do you think?

David Marsh: For the next three to six months, it’s right to keep policy as it is. Next year it would be time for a turnaround in monetary and fiscal policy. German Finance Minister Olaf Scholz himself said that we have to return to more solid public finances. If assistance programmes become permanent, problems could arise in the long term.

CS: What do you mean?

DM: As Friedrich Merz said recently: the bill will have to be paid by coming generations. At some point we will reach a limit on debt, not so much in Germany, more in other EU countries. It remains to be seen whether Italy or Spain can reduce their debt without some form of rescheduling. In the medium term we are probably on the way to a transfer union where Germany has to take responsibility for other highly indebted countries. Politically and economically, this is a threat to the euro area’s cohesion.

CS: At the moment the finance ministers prefer to spend a lot of money.

DM: Yes. You can see that in my home country, Britain, where Chancellor of the Exchequer Rishi Sunak is now very well liked. A finance minister’s fate is to be unpopular. If he’s too popular, something has gone wrong.

CS: Will the European Central Bank ever reach its inflation target of around 2% and does this target make sense? The billions of euros in bond purchase programmes have hardly had any effect on this.

DM: 2% was a reasonable goal in the 1990s. That was a sign of moderation compared to the inflation rates of the 1970s. Now 2% seem a bit ambitious, especially since the large purchase programmes have failed to achieve the inflation goal. But I don’t think it would be right substantially to loosen the inflation targets. Because after the crisis, inflation will probably return, also due to bottlenecks on the supply side, I am convinced of that. One should establish an inflation range of 1% to 3 % over a period of five to seven years. That would give the central banks a little more flexibility.

CS: To what extent are central banks independent from politics?

DM: There is a danger that the crisis will make them mere appendages of politicians, who will use inflation as a means of lowering debt. As prices rise, so does gross domestic product. As long as it grows faster than debt, the debt ratio will decline. Central banks must be able to counteract this tendency if inflation starts rising again, even if this goes against the interests of politicians.

CS: But at the moment we are a long way from high inflation rates.

DM: Indeed, low inflation is particularly detrimental for debtors. The compensation is that interest rates are very low, including as a result of ECB bond purchases. At some point, however, interest rates will be higher.

CS: Are the bond purchases not already an expression of political influence?

DM: This is a major area of contention in the ECB. Politicians would very much like the pandemic emergency purchase programme to become a permanent facility. This is a difficult balancing act for President Christine Lagarde. I suspect the PEPP will be extended [beyond next summer]. One hears the joke doing the rounds: there is nothing more permanent than a temporary ECB programme. This is a danger for central banks if they are unable to end temporary emergency programmes because of pressure from politicians or the market. The ECB must be able to signal that is considering normalising its monetary policy in the future.

CS: The communication of central bank governors is an art in itself. How good a communicator is Christine Lagarde?

DM: She is a good politician. It remains to be seen whether, in the eight years of her term, she will be seen as a good central bank governor. She is in an unenviable position. The central bank, and its president, suffer from the ineluctable birth defect of the monetary union, which was and is not a political union. It links 19 countries with relatively independent fiscal policies. French President Emmanuel Macron exploited Angela Merkel’s temporary weakness in 2019 to bring Lagarde into the job as his favourite candidate. She lacks the technical background. Unlike her predecessor, Mario Draghi, she headed neither the central bank nor the treasury, she was not an investment banker and she has no PhD in economics. At the beginning of her term, she was rather pithy in her statements, now she talks a lot without really saying much. She should go for the middle ground – less is more.

CS: Is the ECB’s monetary policy helping to exacerbate the problem of unequal distribution of income and wealth?

DM: The ECB would disagree. In terms of incomes, the ECB has made a massive contribution to reducing the gaps. But it’s different with wealth. Central banks around the world are contributing to widening the gap between the better-off and the poorer parts of the population. Their monetary policy has led to a big increase in property and share prices. This also gives populists a boost – as Finance Minister Wolfgang Schäuble warned, in his sarcastic way, in April 2016.

CS: Why is the perceived inflation rate currently so different from the official one? As some critics suggest, is it because the shopping basket on which the inflation rate is based is no longer up to date?

DM: Actual inflation is likely to be higher [than the official rate]. Most people probably find it difficult to understand how the inflation rate can be negative. Rents are probably not adequately reflected in the shopping basket. These and real estate prices are very important for the cost of living. When these prices go up, this causes resentment among ordinary people. If assets such as real estate were better reflected in the shopping basket, it would help narrow the gap with perceived inflation. That would be better for the credibility of central bank policy and would contribute to its normalisation.

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