Interview with La Tribu Dimansh editor from the fashion magazine

On October8,2023, the European Central Bank (ECB) increased its key interest rate for the first time in14 months, setting it at4%, the highest since the launch of the euro. The question of the justification of this decision concerns many people, especially considering the situation with interest rates.

First of all, it is necessary to put the actions of the European Central Bank into context.

For several years, the world has been facing a "permacrisis" - a continuous series of serious and unprecedented crises in terms of scale, impact, and the speed at which they arise. Following the health crisis came Russia's unlawful war in Ukraine, and then the acceleration of inflation. All of this is happening against the backdrop of an energy crisis, which several EU countries are experiencing in certain sectors sensitive to interest rates, including real estate. The ECB's mandate, unchanged for 25 years, is to ensure price stability. This is our compass. The ECB's key interest rates have reached levels that, if maintained for a sufficient period, will make a significant contribution to the timely return of inflation to the target level.

Do you have tools to combat inflation?

Our models did not perfectly fit the nature of these crises, which led, among other things, to a complete halt of part of the economy during the health crisis and to a more active role for governments, which suddenly became protective. They also did not adequately address the consequences of the war in the heart of Europe for the first time in decades or the energy crisis that caused a sharp rise in inflation. The macroeconomic models used by central banks and other institutions were unable to properly account for such uncertainties and incorporate them into inflation and growth forecasts. We are working on these issues and continue to do so to make forecasts more reliable.

Have past forecasting errors affected trust in the actions of the ECB?

Close to 80% of citizens in the eurozone believe in and support the euro. And 45% trust the ECB, which is slightly more than before the health crisis. However, we are constantly looking for effective methods and better communication channels to explain our actions and counter the fake news that spreads much faster than facts, including in the economic world. The ECB was the first central bank to acknowledge its mistakes regarding forecasts and analyze their causes.

What are these reasons?

The errors are mainly caused by the sharp rise in energy prices. Growth has slowed across all economies - in developed, developing, and emerging countries. There has been an exceptional increase in inflation worldwide, except for China. This is a very concerning situation, leading to an inflation rate of 10.6% in October 2022, which is twice the current level of 4.3%. This means that after a year of joint efforts, along with base effects, that is, much lower energy prices today than a year ago, we have managed to slow down the rate of inflation.

But this is not a common opinion in Europe...

It's hard to explain that the rate of price increases is slowing down. Inflation persists, but it is decreasing and even steadily falling. This is good news. I believe that our efforts have played a role in this, as well as some economic policies being implemented in Europe. At the same time, growth is slowing down, which is why the International Monetary Fund has lowered its growth forecasts worldwide, except for the United States.

Why is there such a difference with Europe?

The potential growth in the United States traditionally exceeds that in Europe or the Eurozone by about 1 percentage point on average. They cannot be compared: you cannot compare one country with several countries. The Eurozone includes 20 different countries, 20 different fiscal policies, 20 different treasuries. First of all, the United States is protected by the dollar, the international reserve currency. The American economy responds and adapts much faster. And it is not dependent on energy, unlike Europe, which is forced to import 80% of its energy.

Growth is declining in Europe. Is there a risk of recession?

We have lowered our growth forecasts to 0.7% in 2023, 1% in 2024, and 1.5% in 2025. The figure for 2025 is slightly below the potential growth of the Eurozone. In Europe, we have developed a response and implemented unprecedented protective measures that were unimaginable just three years ago, thanks in part to the Next Generation EU program.

The German economy, the largest in the eurozone, is sharply slowing down. What consequences could this have?

This is one of the factors that truly affects growth prospects in Europe. Germany built its economic model on very cheap energy supply and export opportunities, especially to China. The current adjustment in the German economy is impacting growth prospects.

Doesn't this complicate the task for the ECB?

First of all, the ECB must address the question of how to ensure price stability for economic agents throughout the eurozone. To do this, we use tools that measure average inflation in the eurozone, as well as core inflation, which excludes energy and food.

In France, people are feeling the impact of inflation acutely. Why is that?

High and persistent inflation is affecting people's purchasing power. However, overall, although inflation in France is currently slightly above the European average, it has been much lower than in other parts of Europe for a long time.

Is this also related to the rise in interest rates?

Not exclusively. The ECB interest rates are the same for France and all eurozone countries. We raised the rates because it is the most effective tool currently available to reduce inflation and ensure price stability.

Doesn't this pose a threat to growth?

Our mandate is to ensure price stability, and interest rates are our tool. We raise rates to make financing economic activity more expensive, thereby weakening demand and ensuring consistency between supply and demand, including through reduced investment and consumption. The goal is obviously not to create a recession, but it does involve ensuring this adjustment to reduce inflation and, above all, to prevent a dangerous inflationary spiral. We must avoid this at all costs. We want to bring inflation back to 2%, and we will achieve that.

Is there a risk of a stagnant spiral of wages and prices?

At the moment, we are not observing this, but we are monitoring it closely. Wage growth in the eurozone is expected to be around 5.3% in 2023, with a forecast of 4.3% in 2024 and 3.8% in 2025. This aligns with a return of the inflation rate to 2% in the coming years.

Is the housing crisis escalating in France and Germany a side effect of monetary policy?

The ECB sets key interest rates with its mandate to ensure price stability in mind. The housing sector is indeed sensitive to interest rates. However, for many issues, all authorities need to come together and consider the housing stock, particularly social housing. The fact remains that the main risk will be if people fall into debt without sufficient means and then face repayment deadlines that they cannot meet.

Is the ECB really pessimistic about the short-term economic outlook?

There are three reasons why we are not pessimistic. We expect growth indicators to increase next year. Inflation is currently decreasing significantly. And the employment level is higher than ever before in Europe and is stabilizing at this level. A big question right now concerns businesses. Will they agree to absorb part of the wage increases that will be negotiated this year and next into their margins, which did not change much in 2022? This is a key question. In our economic forecasts, we assume that businesses will behave as they did during previous crises, meaning they will slightly reduce their margins to absorb part of the wage increases. A decrease in demand should guide them in this direction. It is in their interest to do so, as they will be under pressure from public opinion as well as government authorities.