Interview with governor of central bank of Estonia

Interview with Ardo Hansson, Governor of Eesti Pank and Member of the Governing Council of the ECB, conducted by Stefan Riecher and Jeff Black on 16 July 2014 in Frankfurt

On latest ECB stimulus package:

“One of the features of this set of instruments is that they are planned in a sequenced fashion. Some of the elements kicked in immediately. Others, for example, the targeted long-term loans are announced but to be implemented over two years. The first implementation will be in September, that’s when you have more detailed information about the initial take-up and it will take some time to feed in into the indicators. So I think unless something really unexpected happens that puts us on a different inflation projectory than the idea of doing something more at this stage shouldn’t be part of our baseline assumption. You need to think about contingencies and be prepared. But there’s really enough to deal with the long-term loans now and get them running and I don’t think we should, after having just announced such a substantial package, already be thinking about any next steps. Let’s take the time to get this up and running first.”

“Those measures should be enough related to our baseline scenario but, of course, there’s always possibilities to evolve a little bit more in one direction or another. So in the end you can’t rule out that things will evolve a little bit different than the baseline. But in our baseline assumptions, considering our forecasts, we think the package is pretty substantial and it is appropriate.”

On targeted longer-term refinancing operations:

“The final aim is to have an impact on prices but one of the transmission channels is the credit channel. I’m reasonably optimistic it is going to work but it hasn’t been tried so there’s maybe a bit more uncertainty than with other things that have been tried before. We don’t know much about the detailed impact as we might have known with some other instruments.”

“Had nothing else changed in the recent period, with only this instrument implemented, the effectiveness could be quite limited. But if you think about other factors, the global recovery, that might create some underlying support for investment demand. Maybe we do see a level of capacity utilization in certain sectors a little bit higher now and there’s more fundamental support for greater investment.”

“Some of my concerns were that the targeted long-term loans are operationally somewhat complex. That’s one of the reasons why you have this window of several months between the announcement and the implementation. A bunch of details have to be sorted out. There are legal acts that have to be adopted to apply this instrument. The preparations are underway and we’ll manage but it requires very detailed definitions of certain variables, of monitoring, of performances. It is operationally complex but it is doable.”

“One worry was about how you shouldn’t discourage banks from writing off bad loans if necessary. You don’t want to have a measure that looks like credit provision is declining if a bank is writing off a bad loan. Then you are penalizing them for actually doing the right thing. You want them to report accurately but you don’t want this scheme to be inducing to defer necessary write-offs to show higher lending. All these things are now being taken care off.”

“We don’t want these loans to be used for mortgages, for government bonds, for financial-sector lending. We can’t really prevent carry trades over the first two-year period but banks have to pay back the money if they don’t use it in a way intended. There’s an upfront measure related to your balance sheet and then there’s the targeted component. Without that initial part, take-up would take an awful long time, if it was all based on net increase in lending, then the volumes involved initially would rather be small.”

“You’re getting long-term money and lock it in. For somebody looking for term financing, comparing this to an option with a variable it’s obviously a bit more attractive. It’s about what kind of trend a specific bank expects.”

On further interest-rate cuts:

“You can’t rule out that there’s a little more you can do. So is it really true that you’re at the floor? Not technically. But for all practical purposes you’re very close. So at that point, it’s almost semantic how you characterize that. When you’re used to 25 basis point changes, 10 basis point changes, going forward you’re not talking about big additional things. We’re in the margin of error.”

On the timing of interest-rate increases:

“That’s not an immediate risk, we’ll have to deal with that when it arises. Every policy creates an exit issue at some point in time, but I don’t think we’re there yet.”

“There’s no single trigger. It’s a lot of factors you run through, trying to come up with a medium-term assessment. The baseline scenario foresees that inflation will remain relatively subdued for some time. If you’re to be surprised on the upside, if suddenly that were to change, it’s a contingency and you reassess the situation. But right now we don’t see that as likely for some time.”

On asset purchases:

“Technical work on asset purchases is advancing but there has been no decision. There is readiness if inflation stays too long for too long to use unconventional means but the idea now is to explore if and how you develop new tools, expand the toolbox. The tools are not sitting there already but it’s worth developing them. Then there’s the other question on if and when to implement them.”

“We haven’t set a firm deadline on an ABS program to say by date X it all has to be done and ready. I suppose if the contingency materializes over the space of a certain period of time, then maybe. But this is nothing that develops overnight.”

“Certainly, for example in the U.S., this market is more developed because there is this element of government behind it. You don’t want such purchases when you’re the only player in the market. There has to be a sharing arrangement but I think to the extent that you can develop new sources of non-bank financing it could be useful. It’s is a longer-term program but if you can get such an ABS plan going through regulatory reform, legal reform, and so on, and it has a more diversified non-bank focus, then it’s probably good for a lot of reasons. But that element alone takes time and it’s not going to help with immediate issues. It’s more of a medium-term plan somewhere down the road.”

“Of course, if you start somewhere, the trade-off is that an ABS program is going to be rather small. You may have some kind of an impact on credit allocation to certain types of firms versus others but the quantitative impact on demand is probably not going to be that large. It may be good in a very long term because you can get a market going and people gain confidence, they start issuing these securities. But that’s a very gradual process. To build up the volumes to reasonable levels, that takes some time. It’s probably not going to have much of a quantitative impact but it might help you in the more distant future.”

“If you want to have more of an impact you’ve got to be thinking about a broader set of asset classes, broader-based asset purchases. There’s work on the way on that as well but in a European context it’s very tricky to design these rules, what types of things to buy, and how much. Some of these markets are not so liquid as others. There are a lot of little issues. Some governments have issued many bonds but they are not highly traded. There’s a lot of these operational details that have to be worked through. You have to think about the effectiveness and the impact and all of that takes a lot of preparation. It’s worth preparing, it’s worth having more tools, but I don’t think Quantitative Easing is a tool that’s needed right now.”

“It would have to be a serious contingency that you see a scenario that has materially changed. If you were to see that then I think you consider it but I would say let’s focus on getting these existing, newly announced measures going. The other possible options are out there as contingencies. You certainly would want to see some real kind of sluggishness in demand, something like we saw in 2008. You’d wanna see really a much more material risk of scenarios which take you away from your target.”

On the risk of bubbles:

“I think it’s helpful when we’re reminded of those risks. Probably in other jurisdictions you see a little bit more of that because they just happen to be a bit more advanced, we are at a different point in the cycle. There the risks may be much more immediate. In Europe, there are certain jurisdictions where those risks might be real.”

“We have to think about those risks, and it’s helpful to think that when we implement certain policies there is no free lunch, and we have to be much more forceful and take this issue of macroprudential policies much more seriously. Probably a year ago I would have thought it was going to be an awful long time before we even get to the point where that even becomes an issue. But now, some asset prices are certainly high. You don’t see a euro-area wide impact on the typical financial-stability risk, property prices. But there’s a trade off: the longer you are in a low-interest-rate environment, you start getting financial stability risk. But whether at a European level or a local level, someone has to actually go beyond the rhetoric of just mentioning this, and actually combine these issues of relatively accommodative monetary policy and maybe some countermeasures to deal with financial stability risks. In other jurisdictions maybe this debate is more advanced because objective reality is already making it an issue.”

On macroprudential tools:

“Macroprudential tools are work in progress. Part of it is happening at the ESRB. Countries are already notifying the ECB of certain macroprudential measures at a local level. In Estonia, we set the systemic risk buffer at 2 percent. Given that these risks are probably growing, it’s maybe more important to develop the capacity, these instruments. It’s good to have this double system where the country or the ECB can initiate action or overrule. As a central bank, we’d like to think we have less inaction bias. But in most countries, as the government has quite a bit of a role, and for example in an election period you can have quite a bit of inaction bias. So to have an institution that can say, you’re being too slow, and you should be more front loaded with you adjustment, that’s a very good thing. Maybe that also shows how hard it is to forecast these turnarounds. A year ago I would said it would be quite a long time before it ever becomes an issue, because everything is so subdued, and now we find it is at least being raised as an issue. But a central bank has to start from its mandate, and we have to pursue the policies that we are pursuing, but then the macroprudential authorities have to be more vigilant.”

On sanctions against Russia and their impact:

“It’s a very fluid situation, obviously we’ve run scenarios on different possibilities but since the range of possible outcomes is so broad, if something where to happen it would all depend very much on specifics. Maybe the prime impact is on confidence in general. If there’s an enterprise thinking of investing in Estonia, people might have a bit more of a wait and see attitude. But in terms of trade flows we haven’t seen anything substantial yet. Obviously that situation can change. In our own economy, Russia is ten percent of our exports, but a lot of it is not high value.”

On Estonia:

“As for the latest GDP contraction, the baseline we see is that there are quite a lot of one-off factors at play. We used to have the highest inflation rate in the euro area, now we basically have negative domestic inflation. There are a lot of specific factors. We had a liberalization of power prices last year, power prices increased by almost 30 percent in 2013, now they are declining by about 13 percent. We built a power cable to Finland, and it’s cheaper to buy electricity from there. A positive supply shock. This is temporary, though, and once these one-off factors work out, we’re probably going to have inflation that is somewhat higher than the average in the euro area.”

“On the GDP side there were one-off factors that are beginning to wash out. The whole economy is a bit less balanced than it used to be. A year ago we were sitting with budget deficit of 0.2, we had a current account deficit of about 1 percent of GDP, the loan deposit ratio was about 100, everything was extremely balanced. Now we are starting to see that balance fraying a bit. Wages are growing faster than productivity, and a robust increase in property prices and a little bit of widening of the current account deficit. There’s a bit of an incipient imbalance building up, which could be a problem if it continues. However, we have lately seen a bit of a correction in the property sector and wage growth has started to come down. There’s chances of a smooth correction but it’s not guaranteed. We have this legacy of having a boom and we’re trying to work out of it, so we’d like credit growth to pick up very very gradually and not get back into a boom situation.”

“We draw some consolation from the fact that the property price increases aren’t being driven by bank credit. We’re at a very different point in the cycle from many of the euro-area countries. We are trying to use the macroprudential instruments when required, we’re trying to develop the loan-to-value ratios to have them as an option to consider. We could always be a bit of a pilot for these instruments.”

Published in: Bloomberg News
Reproduction is permitted provided that the source is acknowledged.

Published date:
Published in:
Bloomberg News
Source: Bank of Estonia

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