Interview with Die Zeit

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Kolja Rudzio

31 January 2024

Mr de Guindos, Germany is in a recession, the entire euro area economy has not gained momentum for a year now. How much of this is down to the ECB?

There are three reasons for the weak growth in the euro area, the first of which is inflation. It has curtailed purchasing power, causing consumption to fall. The second factor is the noticeable slowdown in global trade. And the third is indeed the ECB’s monetary policy. When we raise policy rates, businesses and households see their financing costs increase. That results in less consumer spending, less investment and subsequently weaker growth, which in turn slows down price increases. That’s how monetary policy works.

Could you quantify the extent to which you curb economic growth through higher interest rates?

That is very hard to say. Monetary policy works with a lag. We can see that banks are already charging higher interest rates and so have tightened their financing conditions. But assessing the extent to which this is already reflected in the real economy – in other words, in consumer spending and investment − is far more difficult.

Research shows that the full effect of interest rate increases is only felt after one or one and a half years. You decided on your most recent interest rate hike four months ago. So is the biggest damper on the economy still to come?

As I said, that is difficult to calculate. My personal estimate is that the greater part of the tighter financing conditions, perhaps two thirds, has been passed through to the real economy already.

The consequences in one area, housing construction, already can’t be overlooked. In Germany, as in many other countries in the EU, fewer and fewer building applications are being submitted although housing is urgently needed. Do we simply have to accept that as collateral damage in the fight against inflation?

Within monetary policy the main tool for fighting inflation is to raise interest rates. However, we cannot set different interest rates for different economic sectors. In the real estate market, the higher interest rates also help prevent a further increase in prices, or an overheated market as was seen during the low interest rate era over the past few years. A measure of calm is a good thing in this area at least. Targeted fiscal policy should address construction and housing problems.

But fewer houses are being built because of the higher interest rates; fighting inflation is already taking its toll…

Please don’t forget that when inflation abates and wages increase in relation to prices, then people regain their purchasing power. That generates more consumer spending and an economic recovery. So by reducing inflation, we are also contributing to more growth in the future.

How do you assess the growth prospects for the euro area and Germany?

In December we projected that the euro area would grow by 0.8% this year.

That is low.

I personally think that the prospects have even deteriorated in the meantime. Some of the risks mentioned in our projections have materialised: world trade has lost momentum, geopolitical uncertainties have increased, and our interest rate hikes are being transmitted forcefully to the economy sooner than expected. So growth in the euro area could even be slightly below 0.8%. But let us wait for our next projections to be released in March.

And how do you see the prospects for Germany? The mood among many entrepreneurs, investors and employees here is quite gloomy.

In my view, the German economy is first and foremost burdened by two factors. First, the energy crisis, which was deeper in Germany than in the rest of the euro area. The second factor is that the German economy is strongly geared to manufacturing and exports, especially exports to China. As growth in China is slowing, Germany’s economy is performing worse than that of other industrial countries. But I clearly remember being deputy finance minister in Spain in the early 2000s when Germany was considered the sick man of Europe. A few years later it was suddenly the rising star. So I wouldn’t be so pessimistic.

Do you not see any major problems in Germany?

There are structural problems with energy supply and not enough has been invested in infrastructure over the past ten years. But that can be changed. And I am sure that, if China’s future growth is not as strong as it was in the past, German firms will soon export their products to other countries. Germany is competetive and can resolve its problems.

Euro area inflation was still 2.9% in December. When will it fall to the ECB’s target of 2%?

According to our December projections, this should happen in the second half of 2025. But inflation figures have mostly brought positive surprises recently. I think that inflation will be slightly lower than we have predicted.

Your prediction for this year is 2.7%. Does “slightly lower” mean 2.5%?

I wouldn’t want to put a figure on it.

What’s so bad about inflation being 2.7% rather than the 2% that the ECB is targeting?

Price stability is typically defined as 2% in many advanced economies such as the United States or United Kingdom. We are also targeting an inflation rate of 2% in the medium term. If inflation is significantly above that, there is a risk that people start expecting rising inflation and so demand higher wages, for example, which in turn pushes inflation higher still. This increases the risk of a wage-price spiral. Competitiveness suffers too as products become expensive in international comparison because wages have grown too much. In addition, a central bank loses credibility if it continuously fails to reach its target.

The ECB is often criticised for hiking interest rates too late. Is there a risk that it will now lower the rates too late?

I don’t think so. Also, we changed course as early as December 2021, long before our first rate hike, when we announced that we would be gradually ending our bond buying programmes. This was a first step in the normalisation of monetary policy. But even if you do assume that we were late, just look at the outcomes: within 12 months inflation has fallen from more than 10% to less than 3%, and no deep recession materialised. So far, despite the delicate situation, we have managed to keep the balance between inflation and growth, also thanks to the very good situation on the labour market. The economy did not collapse. This is very important for the prosperity of people in Europe.

But it is not all just thanks to monetary policy, is it?

Of course there are other factors at play, like steeply falling energy prices and the easing of supply chain bottlenecks. But monetary policy has played its part.

When you started hiking interest rates there were concerns, even within the ECB board, that highly indebted countries like Greece or Italy could get into trouble because high rates make new lending more expensive. That could have led to another European debt crisis like the one in 2009. Why has it stayed calm?

Banks in Greece, Italy, Portugal and Spain are in much better shape now than they were back then. Their stability is not in doubt. And I know what I’m talking about – I experienced the European debt crisis in my role as economy minister of Spain. In addition, the countries that were in trouble have since improved their competitiveness. This is thanks to the reforms initiated at the time. I worked on those too, cooperating closely with Wolfgang Schäuble.

Schäuble, who passed away a few weeks ago, was the German minister of finance at the time.

I’m sure that Wolfgang would be very pleased with the progress Greece, Spain, Ireland, Italy and Portugal have made. He called for reforms aimed to fix government budgets and the banks, and strengthen competitiveness. Many of the policy recommendations he advocated have paid off. In some ways, the economic performance of Southern European countries may even be better now than that of their northern neighbours!