Former ECB Chief Economist Peter Praet on What's Next For Central Banks

of the big themes of right. So, we've had this economic crisis, and we've seen various responses to it from central banks, and we've seen various government responses to it as well, and now we're sort of waiting to see what the combination of those two things actually looks like and how monetary policy interacts with fiscal policy. I feel like that's that's the thing we're all watching, right, Yeah,

I think that's that's fair to say. And I think you know, and again, this is sort of for people who have listened to several episodes, um it's at this point is a retread. But I always think it's important that a lot of these debates were happening already going into this crisis, about the sort of limit to monetary policy even in recent years, whether central bankers needed new tools, whether there needs to be a greater emphasis on fiscal

policy and so forth to accelerate growth. These were already big debates that were happening pre crisis, and like many other things, this crisis has really accelerated them. Yeah. Absolutely, It's funny how the crisis is doing that, really accelerating trends that were already in play. But I feel like the other big question around central banking has to be the continued misses on inflation targets as well. So we've now have had many, many years of central banks around

the world missing their inflation target. No one quite knows is why. And that's why even before we were starting to see that discussion about whether or not something else

was needed besides pure monetary policy. Yeah, exactly right. And you know, this is a pretty profound issue for central banks because I think, um, you know, everyone agrees as a little more complicated, but on some level, the premise of a lot of monetary policy, at least traditionally, or sort of interest rate policy, is that there is this sort of given take or balance between inflation and full

employment or inflation and robust growth. And so I think if there is some question about what it takes to hit the inflation target, or why inflation doesn't pick up even when the unemployment rate drops to historically low levels, I do think to some extent that really calls into question a lot of the traditional models. Yeah. Absolutely, and I feel like this has been a long running theme

on all thoughts. Now absolutely so I'm very excited today we're going to be uh speaking to a huge important guest in the world of central banking, monetary policy, economics, someone who's uh really uh, just a big name, someone very excited to talk to. We're gonna be speaking with Peter Pratt. He is the former chief economist of the

European Central Bank. He was on the the Executive Committee of the Bank, crucial decision maker for eight years from eleven through June twenty nineteen, so has been right in the middle of things up until very recently, sort of almost right up against the current era and U Currently he's a senior fellow at the University of Brussels, and we're going to be digging into these topics the ECB, the future of central banking, macro policy overall, very excited

about this conversation. Peter, thank you very much for joining us. So, Peter, thank you so much for coming on. I mean, you know, Tracy and I introd we've really picking apart these topics for a long time before we dive into the sort of bigger theoretical questions facing central banks. I'm just curious your perspective right now on the recovery in Europe. Do are the existing set of policies enough to make the

recovery from the crisis self sustaining? Can you get back, can you get back to pre crisis levels, or does there need to be something further yet, either from fiscal authorities or the European Central Bank to return to trend. I think you have to distinguish a little bit the

short term and the medium term here. I think it's always the case, but I mean it's particular that's is in the situation because you have the second wave, which has been very strong actually and has led to lockdowns, you know, in different countries and different degrees, and for that sort of situation here, I think it's absolutely clear that you need more this stimulus, uh and basically from the fiscal authorities so I think that's that's accepted by

most economists. I think that's to me very clear. The role of the central bank here, as has been communicated recently, which is vlatively knew, actually is basically that the central bank wants to preserve the easy financial conditions that you have and not to try to end accommodation. Basically, the message you get from the central bank is to say,

financial conditions are okay. You know that easy across countries, also not only on average, but across countries, and so it's important to preserve these conditions in a situation where the expectation is that governments are going to come with new stimulus measures. I think that's that's fair enough. I think that's that's fine. I don't see why, you know, by adding accommodation, trying to bring the curve, you know, the yield curved lower than what it is today, would

stimulate you know, the domestic demands. I don't think it will. So Basically, some economies that have even alluded to the said that to some extent it resembles a yield curve control. You know, you want to keep the curve, the interest rate curve, you know, more or less as it is today. But to do that, to do that, you may need of course to buy more bonds, given a huge issuance

of government bonds. So just to stabilize the conditions, you may need to add you know, another round of QE basically on the what is called the Tell show, you know, the pandemic emergency purchase program of the e c B. That's the short term and you want to bridge bridge what well, I mean, it's a vaccine story. The vaccine is for the time being not taking you know, as a as an upside, a very big upside in the

projections of central bankers in general. They just say when it was more or less more or less already in our scenario before the announcement, you know, the two announcement we handed in recent weeks. But I personally, I think the vaccine now has the much higher probability. So the variance actually the uncertainty around the seeing the spreading of the vaccine, you know, I think this is you have reduced the uncertainty. Is that would be a positive factor.

So for the time being, the simepral Bank and d CB, I think in particular, they just want to bridge it to that situation. In the second half of next year, so you don't need to do much necessarily, but you want to ensure that the financial conditions, the easy conditions that you have today, are maintained in a situation where governments are going to spend you know more. What comes after, well,

we can discuss that picture, because that will not be easy. Yeah, we're definitely going to get into that, but before we do, I mean, just looking forward to next year, there are a few people who, despite everything that's happened, are pretty optimistic about the future of Europe. So, you know, we now have the common debt issuance, we have the fiscal transfer that we've been talking about for many, many years.

Brexit might finally be over. Do you buy into the idea of things looking up for Europe as a whole. You know, there was this this famous quote, you know, from Jean Monette by saying your Europe will be forged in crisis. Always said, you know, prevention is better than you know, reacting to christs. Of course, you have to react to crisis better than the opposite. But I think

that's a little bit risky strategy. I mean, because Europe in the past, you know, events that we had with the global financial crisis, the sovereign debt crisis, and not the pandemic. Well, the Europe was not really prepared for that sort of situation. And so the good news, of course is that in crisis Europe reacts very strongly. Uh, And that's a positive news. But on the other hand, very often they account you know, by the events, and the events go faster than the capacity you know, to

reform the institutions. Now, they came, as you rightly mentioned, with extremely important decisions in the middle of the crisis, the pandemic crisis, coming with transference insurance of common debt. But they're all always saying, you know, the communication is that this is a one off, you know, it should should not project that you're going to do that for the future. These will be discussing discussions for after and

we will see it's it's you. We cannot prejudge, you know that that there will be no sort of more permanent transfers. But I think it's important what happened. I wouldn't call it, as many people say, you know, Hamiltonian moment, moment, you know, referring to the US history. I would call it that way, but I would certainly recognize that this is very important thing. Had don't this happened, the Union

would have collapsed. I think this is you know, the head of states where so, you know, worried about the potential consequences on the Union of the COVID crisis and the economic effects of the crisis, that they as as they did in previous events, you know, came with with this huge you know, stimulus program at the European level. So I think it's positive, but it doesn't guarantee you

that you have the right institutions. Now you're puts in place, institutions like banking suggusion for example, at the global talentcial crisis. But you know, then they tend to to to to go backwards, you know, to not to to find the lines what they've started with, you know, income with new problems. So I think it's there is always an element of ambiguity in the institutional reforms in Europe that puts risk you know, to the to the to the Union. Can

you explain that further? I mean, you had a front row seat to all of this for several years, and from the outside looking in, that's certainly the appearance that there will be some big shockun awe announcement, We're going to spend all this money, We're going to launch some new vehicle. And then it feels like there's like there's a inert shaw or the trifical force, and things start to slow down and things start a look less oppressive

than they appeared. What are the forces that cause what you just described where things the sort of the ambition seems to slow over time? Well, here you know, the final approval for the recovery plan you know is not done. Because you know that that basically two countries Hungary and Poland threatening to vito the whole project. And so that means there is today today uncertainty is about that on on that point just too because this is news today.

I mean, I would not be too worried because in Europe, you know, when you cannot agree with forty seven countries, you can have if there were a coalition of willing. You know, at least with nine countries, you can still within the European treaties, you can still do the things they want to do now, so I think they will, They will finalize at least for most countries what they decided to do. That means big you know, expansion plan. They will do that. The question now, which is which

is new. I mean, this is really real money for a big part of that. The main concern actually that most analysts would have is how do you spend that money? I think money would be spent, but how do you spend that money? Because I mean, at some point you to reimburss that money. And the impact of the COVID crisis usually is to lower your GDP potential growth, you know, and it we can see economy you know, for for a while. So the whole plan, that's why it's called

recovery plan. It's basically directed for investment, and the investment as supposed to increase potential growth and that would mean the reimbarrassment of debt common that also easier in the future. But that's the biggest challenge now in Europe. If it's a success, that means that the real money there will be real money when the real money it's spent, if it's spent correctly across the re addictions in the different countries. I think that could serve you know, very positively the

Union in the future. Now, if it's the other case, there will be you know, the political reaction in many countries will be totally the opposite. I mean you can imagine, you know, you give grants to one country that has been hit more part of that money is paid by richer countries, and then that money is unwisely spent you know, in consumptions. Well maybe income support. That's not the objective now, and there will be a surveillance process how the money

is being spent. If that process is well done, I think then we can start talking about the game change about all this. I would say for today, this is the one shot is extremely important, I think, and certainly for the business cycle. But for the longer run, I think we have to see how this money is being used and and and you cannot tell today because you know,

it's it's complex. Also, so that last point actually relates to a question that I wanted to ask you, which is there does seem to be a consensus developing that monetary policy is going to be used to augment fiscal policy or whatever the government does. But for the e c B and for the European Union, I mean clearly they have a different set up than say the Bank

of Japan or the FED. Is the easy going to be able to be as effective when it comes to using monetary policy to augment piscal policy as other central banks, or what are the unique challenges they're going to face in doing that. No, they're you're right. I mean they're unique challenges because you have one central bank and then you have different ministers of finds different countries, so you

don't have a single fiscal policy. But many of the problems we have in Europe are the same as as in Japan or the US, in the UK, so they're not they're common to all central banks. Let me just remind you that, you know, in the eighties the world of central bank can change very fundamentally. There was sort of general consensus that you know, business cycle policy, you know, smoothening the business cycle would be delegated to the central

bank governments. Basically, the Ministry of Finance would basically, of course, let their fiscal policy you know, react automatically, you know, to to as the cycles. But discraction policies would not really be trusted, you know, from Ministry of Finance. Basically because Ministry of Finance they look at the political business cycle and so when they spend the money, it's linked to a political cycle, which is not necessarily the business cycle.

So basically the consensus was, you know, business cycle policy. Basically, you know, when the economy goes down, you lower the rates and then it goes up. If you have inflation, you're tightened. I mean that model a La Taylor rule, if you see, the same simple rule was the consensus. And government basically would look at three things. Basically, they would look at the allocation of resources, you know, hot taxation influences their location of research, for example, they would

look at redistribution of income and wealth the television. And then they would ensure the sustainability of public debt. And so the central banks were kind of independent agencies with a very clear mandate. It could be price stability in Europe as as a primary endate. But basically all the central banks following more or less the same model, you know, business cycle responsibilities. You and you have the tools to do that. And that was the environment in which I

was supposed to work. I work, and I was supposed to work efficiently during these eight years. And what happened is that you know, different things. I mean, one of the things which is coming to many central banks is that we reached the lower bounds so the interest rates went to zero, and so you have a mandate. It's just price ability. But in terms of toolbox, you know, you you hit something, can you you enter new territories. So we tried the number of innovative instruments, quantitative as

you know, negative rates. Also we went into all this and as was said in your introduction, well, the results I think can be debated at least, but for the general public and analyst in general, well, the conclusion is that you didn't reach the two percent that you were targeting. And so one is the issue of instruments that is you know, still debated today. I think the instruments have been efficient, but the question is still open. The serdad.

The certain reason why central banks didn't succeed, and this is one of the points I personally mentioned very often in my communication, is that we had a succession of shocks. You see, you can say, find your monetary policy, including q we would be efficient, but then you get a new shock and put putting the economy down again, and then you try again with your monitory points and then you get again a new shock. I can refer one

of the last shock we had before the COVID. It was what we call the geopolitical shock which hit animal spirits in the manufacturing industry. Basically, let's say that protection list pressure is coming from the United States, and you know, the the the eroding trust in multilateral institutions, the Brexit, etcetera.

So you can see the issue from not from an instrument point of view, like what is the room of maneuver when raised a zero, but you can also see it as a succession of deflationary shock in the economy that complicates very much the central bank action. I think we does these two explanations, and then you have a third explanation, which is the one you just mentioned. Is some people refer that to the flatness of the Philips curve.

That means that you need a hell a lot of monetary stimulus to get inflation, because the reaction of market participants in general, labor markets, capital markets, but especially for product markets is very slow, you know, compared to you to your monetary policy action. So basically saying the world has changed, there's a lot of internet connections across the economies and so there is competition of China, there is a you know, digitalization of the economy. Unions are not

as strong as before, So the relationship have changed. Now if you combine the three elements the lower bound, that means your rates go to zero. And then what do you do. You try other instruments. Suddenly you have a succession of shocks and negative shocks in the economy. And third you have changes in the relationships because you know, the world has changed because of you know, digitalization, globalization,

lack of union power and all these things. Then you get a little bit the story in which we had in Europe. It was even worse because in the global financial crisis, in which we were not very well prepared as as the US and and many other countries in

the world. We had also a sovereign debt crisis, which stressed you know the fact that the monetary union in Europe was not very resilient because you have to prepare for the worst if you if you're in a country, well, in a country, you have a lot of institutions, you know that can be activated very quickly in case of crisis. We didn't have that in Europe, and there was i would say, you know, with a sovereign debt crisis, and we paid a very high price in Europe because of that.

We had a very big shop, you know, following the global financial crisis because of institutional weaknesses what we call the incompleteness of the monetary Union. Now, as I said before, there have been very strong political reactions institutional improvements in Europe, which is very positive. I think, you know, we have banking supervision, we have I think a better capital market union, etcetera, etcetera.

But these institutions I stopped with that. But these institutions today are not yet you know, very strong, sufficiently strong to face the challenges that we have. M I want to focus on something you just said, and this might be getting into some controversial territory, but I think it's important,

interesting stuff. So you're talking about these sort of geopolitical sharks or various setbacks, there's also internal politics and again speaking as someone who just observes from the outside, and uh again you at the front row seat to this. But you know, we saw this sort of uh pretty the extraordinary lengths that Draggy underwent, especially over the course of the europe the sovereign debt crisis, to um you know, expand the ECB toolkit, or at least fit the toolkit

for the the time needed. And that's provoked. UM, that provokes some pretty uh, you know, loud backlash, and we always heard it, particularly from German media, in particular German central bankers, who seem to have a very different view on the proper conduct of monetary policy. UM then sort of the sort of mainstream views that sort of exist

in Europe and the US. And it even culminated into a situation right after you left in the fall of nine in which uh, there was criticism of the Draggy era for their view stoking inflation, and you pushed back on it publicly and you said it wasn't helpful. How much of an impediment was this or is this to the evolution of UM, the e c B and monetary policy to address the various crisis of the times. This sort of very sharp break that there is with the sort of core European or sort of the German view

of monetary policy. How difficult of a challenge was that in your eight years on the executive board. No, you're right, I mean I was very often surprised that in spite of all what you say, that it worked. We always in the Governing Council could design uh. And of course there were some different views in the governing Council, which is not the case today with the COVID shop, which is is a bit of a different situation. But in these years you had, of course a lot of differences

across countries. You know, some like Germany recovered very quickly after the sovereign death after the sovereign death cries and the global financial crisis, not the case of course of

countries like Italy and others. I think the main problem we had in the e c B and I think, especially with Mario Mario Dragi, I think, you know, we were at some point the only game in town, you know, because the political institutions, the institutional settings you know, supporting these sort of situations, very extremely weak in you and so I think that the CB had to take this leadership, and I think a little bit contrary to what you said, at the political level, it was accepted, you know, that

whatever it takes was very much endorsed and accepted, you know, including in Germany at the highest level political level, in the population. Of course, one of the issues is that the situation you know about negative rates. Of course, we had to have negative rates. If you look at the curve in Germany for example, today you have minus fifty basis points for the short term rates minus point five and then when you go to the long end to the tenure you know curve, you get minus fifty five. Today.

If you look at a country like Japan for example, where you say Japan is not a particularly growing country, you know with inflation, well the curve is minus tend to zero, and the US it goes you know, it goes up to point nine percent. So the country doing the best, you know, being a sort of safe asset, gets extremely low rates, and countries you know where the

risk a bit higher get higher rates. And during the COVID crisis we lived again, you know, that situation when markets, you know, get nervous, you have an increase of the spreads you know, across the countries and all the interesting cresses that you find within the Union, you know, as you know emerging you know in the in in the financial asset prices tremendously and at that time Mario had to intervene and saying, you know, we do whatever it takes.

You took that initiative. In the COVID crisis, it was a different situation where there was a full consensus, including to intervene you know, sometimes more in particular markets than other markets because of that particular situation. That's a revolution actually, but it's you're right, I mean, it has been in the governing Council not too difficult to get, you know, a very strong consensus, you know, all all the measures

with it, but not not always unanimity. But it's the length you know of this period, you know, and I explained that by the succession of shocks that we had. I thought in two thousand and eighteen that this time, you know, that's it, they're going to be able to exit, you know, from que progressively, and we announced that, you know, I was, I was there when you know, I proposed you know that at the gnomin In Council at that time.

But then we had again the new shock that came and then now we have a coverage show there came, So there's normalization never happened. Actually, Uh, since we're talking about the whatever it takes moment from Mario Joggy, I kind of wanted to ask you about that. Actually, So when when he made that famous speech he was basically calling the markets bluff, right, was there ever any doubt within the e c B that that just uttering those

words would be enough to stop contagion. What was the debate like before he went out and actually made that statement. I think we can say that the president of the Central Bank to took his responsibility by making, you know, that announcement. So that is a sort of announcement that is not without risks. I think so that I gave him really the credit by taking this risk as a president, because that's as you say something you know it may not work, and you know it worked pretty well, and

then you have to ask yourself why did it work really? First? I mean, you have to be a good communicator. I think that he was. He knew that he would be backed by the Governing Council, even if they would be you know, some problems potentially, but he would be backed by the Governing council, served a strong majority of the

Governing Council. And maybe more importantly to all this is that before the announcement of Mario in July two thou twelve, before that, you had the head of State and Governments that decided, you know, to improve the institutional setting of Europe by putting in in place, you knows, a single supervisory mechanism, the supervision of bank looking at crisis management.

So there was an institutional change which was accepted by government despite the politicians before the announcement of Mariue and I know some politicians at the time they thought that the e CV was not reacting sufficiently fast to the innovations that were decided by the government, and so there was a little bit for the president also the timing of the announcement that uh, the c B had to do.

I think it had to do that, and certainly the c B would not I don't think the ECB would not have made that sort of you know, commitment with all the institutional improvements that were decided by the at the political level, and the markets understood I think pretty well that the politicians would back the Central Bank and they would also improve the institutional environment of the monetary union,

which caused all the problems we solved. Uh. And so the fundamentals, the institutional fundamentals would improve, and the Central Bank would support that by its police commitment and UH, and then you know, the CB came. You know. Then, of course, I was very much involved in the design of what we call the O m T, which was basically that the ECB would you know, do whatever it takes, but it would not be a blank check. It would be subject to a conditionally the framework where institute European

institutions would be at political institutions would be involved. So I think the framework. But it came, and that's why I say, you're will be forced in crisis. Fine, we survived, but it was very close, I must say, And so it worked. The COVID is a new situation. Indeed, so you you mentioned that back inen you had some hope that perhaps the era of extraordinary monetary policy might come to an end and that we might return to just

ordinary monetary policy. But of course that didn't happen, and we don't even seem like, you know, it's anywhere close. These days, the European Central Bank in many ways has been far more innovative than say the FED, and more and trying multiple tools. So you mentioned negative rates, we've also seen dual rates. We've seen not only quantitative easing but also easing through the credit channels in a way

that the FED hasn't done. Essentially all different kinds of efforts to get around the lower bound ef fact that rates are more or less zero don't have much there to go in your view, what are the most promising tools for central banks? What actually works at the lower bound?

That's a very good question. I would say yes, in particular, give credit to very brilliant people in the staff of the CB, and they're still there, very creative people, and it is true that the CBS very often being very innovative. I would caution quotion you that when you look at the toolbox, you have to look at the combination of the toolbox. It's very difficult to say, I take, I pick up one instrument and what is the most efficient one. It depends on the context, It depends a little bit

the circumstances that in which you are. One question today is to say things that have worked in the past do they still would they still work today? So you always continuously have to revisit, you know, your toolbox and the way they interrelate. I think that snow communicated by Christine lag A very clearly that maybe you know in December they will take more or less the same decisions.

You know about the PEP, you know the pandemic, you know emergency preshas program, and the you know, cheap lending for banks they may do that again and that looks quite you know, quite not not a very big innovation that may limit but they will always look at all the instruments in the relationship between the instruments. So you do always this sort of exercise. I think when you answer the question what is the most efficient I would say today today, because as I said, it's context related.

Today I think there is a big issue. You have a COVIDE shock, which hits a lot the Sames, small and medium science firms. Not the very big one that can have access to the capital markets, but a lot of sammes Sames depend very much of bank lending, and the situation of banks is not brilliant. Before the shop, you know, the rate of return was a miserable two percent returnal equity. And they're well capitalized, the plenty of liquidity, which which is good. That makes them resilient, but they're

not very profitable. And so the biggest risk in your when the COVID came was that you've got a credit crunch immediately. And so there was a combination of government reactions, you know, to give government guarantees and there was on the side of the c B cheap lenning funding for lending and other measures that the CB and supervisors took, you know, to make life a bit easier for banks so that they're able to lend to the sector that

has been hit. So I think the most important instruments for today it was because you have a key issue is that sort of shock with lending to sames and simes depend on bank So you cannot just say, as some economies they have written this may be ways that money because a lot of sames you know are you know, cinemas, you know, restaurants, bars, but tourist industry, etcetera. There big the other in services. You cannot just reason like this. I think you have to support because that's some very

good enterprises there. And of course, you know, when you close the business, what can you do even if you're a good enterprise, And if you let some of these firms go down, it's very difficult to recreate the relationship that you had before. And that's a classical problem. So I think here I would say number one that it is the the the how will the bank react, will they continue to lend? And one of the policy tools that you need to ensure that, And it's a combination

of government evention and Central Bank. You know, I would call it even subsidies for the banks. I don't like so much the word. But you know, when you lend, you know it minus one percent two banks on the conditions that they keep the loan book. You know, basically two sam is constant. You know that they're not reduce it. Well, it's a form of subidary of course, because that comes away from the P and L of the Central Bank.

But I think the CM has been quite innovative, you know in lending at negative rates and and and below you know, the money market rates. So it doesn't it's not a guarantee, of course, of success, but I think it's because the banks could decide not to lend, you know, even with these incentives. But that's why the government interventions have been absolutely key as well. So that's that's an

important thing. The other instruments that we have is what we call the PEP, you know, the Pandemic Emergency Purchase Program, which is just like que but it's more than than the traditional QUEI because here you have an envelope that that's the I D and you can use this envelope extremely flexible. So there were a number of constraints on

que before across countries. For example, in this case, you say, well, if I see that the transmission of monetor policy doesn't work well in a particular country because interest rates go up, you know, in that country, and that's not what I want, I will buy more of these bonds. Let's say Italy, Spain, some of the countries which have been hit more by the shock, I would buy more. And Marcus will know that, of course, and there will be some you know, I

will normalize. I will facilitate the transmission of my monetary policy by specific targeted intervention in some countries. This is a revolution because we we we never we never did that. Actually, in the O M team, we had a promise that we would do that under conditionality. In the case of COVID, the CD has an envelope, big envelope and says, I'm going to use my firepower powder to ensure that the

transmission of monitor policy corresponds to what I want. And it was very successful because the spreads went down immediately. But I immediately say that it was successful also because a little bit later you had the recovery fund that came from your pain side. So in this crisis, and I think it should have been in the previous crisis as well. When you have a sort of good coordination between the fiscal authorities, the political institutions in the Central Bank,

I think the impact can be quite good. Uh. And that's not what we had in the global financial crisis, and certainly not in the sovereign debt crisis in the beginning. And then it came and unfortunately it costed a lot in terms of who else in Europe. That that's now we have a good cooperation between the two. When will it end, you know, because that's the next question, of course.

For the time being, you know, there is no inflation, there are some deflationary risk in the economy, and so the cooperation between the two is pretty good because there is no diverging you know, interest aligned on both sides and the inflation is low. That's the mandate of the CB, and supporting the economy for that sort of shock, you know, is also the priority of government. So I mean it

works pretty well. The question, of course, which is not yet discussed in the markets, of course, because I think it's too early, is that supposed the vaccine you know, gets very good results in the second half of twenty one and that, you know, the animal spirits changes changed totally because people start getting optimistic, you know, and there's all this you know, uh, pent up demand. You know,

it's going to be materialized. People start buying, they start going in restaurant, they want to add fun and then suddenly the cycle turns very much. Then of course you have to see what will be the reaction of the central bank. At what point. I don't think the central bank is to rush because the damage to the economy is so big, you know that. I think inflationy forces

will come much later. But I mean, you know, markets like to anticipate all situations, and I think that's a situation that you know, needs a little bit more work from the side of the CB, more compunication. It's probably too early to do that, because that's not a priority

to think, you know about phasing out. You may send ambiguous messages if you do that, but at some point they will have to to to start, you know, in speeches, maybe communicating about you know, how do we see a situation where inflation starts to go a bit too fast? Maybe you know the aligned interest you know that you see today between Treasury and the central bank would not

be there anymore at some point. I don't think it's it's for the time being a situation which is realistic, but it may happen at some point, and as you know, markets always have to be ready for any situation. You know, we always have seen surprises in the past, so you can always have surprises. So that's the strategy of phasing out and the relationship with governments with the treasury. I think that would be a key debate for the coming years.

I mean, as as you said in your introduction, rightly, I wanted to go back to what you were saying about the banking system, because, of course, one of the criticisms of unconventional monetary policy is that it damages banks. It potentially pushes risks outside of the banking system onto shadow financial institutions that we don't really have very good data or insight into what they're doing. And you know, we're now into at least our tenth year of unconventional

monetary policy. How confident can central bankers be that they're going to be able to offset the longer term risks. The longer term financial risks is reach for yield, things like that of their unconventional monetary policies. Yes, I think

that's an excellent question. Uh, for the time being, it's a question around financial stability, and uh, you know, financial stability risks moving from the banking sector to the non bank you know, the non the other financial institutions, and we don't have that to to the same degree as in the United States. So I think it's a it's still in Europe, I would say it's unfortunate. In Europe

you still have a highly bank intermediated environment. And as I said, you have a shocking SAMES which really depends on banks. It's it's it's very simple, so that's the priority. On the other hand, you're right, I mean when you look at the instruments like Hui and when the central banks, for example, also in Europe, I said that also we want to ensure that financial conditions remain very accommodative. Well, financial conditions are equity prices, you know, bond prices, everything,

credit spreads and all that. When you say financial conditions, so it's a sort of compact, you know, a sort of average of all asset prices. And if you say you want to keep them accommodative, I think it's fine,

that's that's your objective. But of course at some point, you know, it gives the impression among market parsities participants there is a sort of backstop or sort of put cheap put option which is put in place by central banks basically saying, well, look, if there is an event somewhere and financial conditions deteriorate, maybe because equity prices certainly fall very much, and what would be the reaction of

central banks? So markets start to internalize the reaction function of the central bank saying this is a quasi objective of the central bank is to keep financial conditions, you know, as they are accommodative. And then the central the market people would then say, well, look there is a backstop.

You know, it's as that pricess fall, you know, anyway, the central banks would intervene and uh and that may lead of course to excess us in the market where people don't perceive your tail risk on the left side, and they basically say there is a backstop on the central banks. So I think central banks have to be very cautious, and I personally, when I was there, always avoided to say things that I read sometimes in communication of central banks. For example, to say we want to

ensure that financial conditions are going to remain accommodative. I think that's fine, that's what they want to do. But what you want to ensure something is well, you know, it's uh, you have to be careful about that. What do you do about this? I mean the answer, the classical answer is to say, well, you have to monitor this sort of risk, you know, so you have micropudential framework, you have regulation and supervision, and that's basically what you

have to do. And uh. And but we know, for example, in the United States, the toolbox in terms of micropudential instruments is not very is not very impressive. I mean, if you look at the U S and I know that in several speeches, you know, some governors in the US have complained about this. So that's an issue. In Europe, I think we have a little bit more in the toolbox at the national level and also the European level,

but essentially the national level. But I would agree also that the toolbox in macrol pudential is not impressive for the time being to deal with the problems you mentioned. I think the central banks in the monetary policy deliberations, you know, when you decide about queen, if you do more quee, I think in the future they need they will need to put in the discussions in the monetary policy discussions to give a more prominent role, you know,

to financial stability consideration. Usually, you know, the monitor policy decisions are not very focused on financial stability in general. If you're a big shock, of course there will be but there will not be a systematic discussion about financial stability risk and the sort of you know, what are the trade offs you know, between the different risks. I think this has started in recent years and I think

it will continue. As Custine I think has rightly said, you know, in response to the German constitutional court issue by saying, you know, we look at you know, the pros and cons of our measures, including you know, the side effects on financial stability. But I think this will have to be done in a more systematic way in the deliberation of monetory policy. It's not easy to do,

you know, this sort of armitage. I think if that had been done in recent time with a compte shock, for example, I don't think it would have changed anything in monetary policy, because they was the reaction of the Central bank to the sort of shock that we saw was very clear, so I think it would have changed. But in the future it may be when you think about the length you know of your interventions in the markets, or the way you intervene in specific markets, like with

the pandemic purchase program. I think there you you need that sort of discussion about you know, other market prices. Right do you see movements which you think are exuberance? You know, the CB for example, has said, you know, when you know, we want to go against non fundamental volatility in the spreads. You know, that sort of a message, the non fundamental volatility in spreads in spreads of some

countries for example. I mean when you're going when you go into that sort of reasoning, it's it's very delicate to do. I think in crisis you can say that because you know there was so much you know, access volatility. But when you're go into more normal time, you know you may have more minor shop and what are you going to qualify as you know non fundamental volatility, what is or close to the fundamentals? And this is a tricky issue. So in a cute phase, you don't ask

yourself this sort of question. Because you have to act and very quickly and frontload your interventions. And I think the CB pretty well with the COVID shock. I was very impressed on the say, by what they did. M M. I want to ask another question about a sort of post crisis risk. Obviously trade to talk about financial risks, but there's also you know, you mentioned all of these um same s, many of which could end up going

out of business, whether it's movie theaters, restaurants, bars. Some will be saved, that may not be saved, and that the thing I'm interested in is hystory sists and the idea that if we have you know, the longer this goes on, the more the economy suffers a sustained degradation of productive capacity that even after the vaccine is let's say we get a vaccine in the spring or early summer, that there's because of this sustained shutdown, because of lots

of businesses that can't easily be reverse. We're just in the US, are Europe or anywhere there's not as uh, we don't have what it takes productively to come back. How big of a risk is that in your view in terms of growth potential post crisis and how much does say, aggressive fiscal policy now help mitigate that risk?

You know, Joe, this this is my main concern what you say, no, because when you look at major shocks like the global financial crisis, but also other shocks, you know that the old shock in the seventies, what you always saw is that the potential growth went down, so the long term growth went down, so that it's it's very much the supply side of the economy. And so you know, when you talk about, for example, the fiscal policy and the sustainability of debt, people will tell you

good news. You know, interest rates are very low and the growth rate is higher, so you know, you can you can have sustainable debt at much higher ratios. The problem, of course is that j you know, the growth rate the long term has also fallen, so interest rates go down, but the long term rates also go down. And the extent to which this happened is not sufficiently factored in in the long term that sustainability analysis that you see among many market participants. So I think this is a

real issue now Europe. You're paying politicians, I mean have understood that actually, and the recovery plan is precisely to try to answer to your question by saying, look, we don't talk about support measures for the economy as it is, but we want to invest, you know, in technologies of the future digitalization. Now the question can they realized that, because as you know, before the crisis, you know, potential growth was trending down in most economies was trending down.

It was not trending up, and so these these problems of the past are still there. So the optimistic view, which I must say, I I don't share really, I think it's going to be very challenging. But the optimistic view is to say, well, it's a big shock. People have understood, you know that your future depends, you know, of innovation and all these things. Europe is going to make a lot of efforts to improve the economy, etcetera, etcetera.

They're going to invest in digitalization. But at the same time, if you look at climate, take climate for example, a lot of the investment will be in climate. And one of the questions, uh, is all these investments in climate, which I think are necessary, and these investment going to increase the potential growth rate. This is not obvious, of course, because you could say, uh, you know, the pollution is lower and in the long run is better for a society.

Is even in the short term, but it's it's better. And maybe you have less retail risks, you know, and shocks climate shocks than before. But in between, you know, your potential growth is maybe not stimulated by that. This is a key question. That's why the r Pain Commission came with a combination of climate change investment and digitalization.

That was I wouldn't I wouldn't call it the trick, but that was the beauty of their plan is to say, look as something that would improve the supply side, and I will make a diffort you know, in innovation and all these things, and at the same time it will be climate friendly. Now as as as as we said before that many other reforms that you have to do, you know, to get you know, to increase your potential

growth rates. So this is the right question, and I think that question about sustainability of public finance is addressed by many economies today in a in a way you know, which politicians very much like of course, because they say, well, are is lower, you know, for almost forever before the growth below the growth rates, so you can you can increase your public that much further, you know, than than what you've thought before. And of course politicians like that.

Uh No, there's just one qualification to that. So I'm worried about this, But there is one qualification I think in the short and you have no choice. So I I still believe that fiscal policies the way they are conducted are absolutely necessary in spite of what I say. But when things will normalize, it will be quite complicated. And that's why you see I say, you know, there may be political tensions in different countries. Then it will

be probably more asymmetries. You know, some countries will do better, and times will be extremely challenging. So you will go with the vaccine and improvements. Where is the phase of euphoria? Uh And then certainly the problems of the past, magnified by what you just said, will come back, you know, enforce, and there will be a lot of claims in order to say look, you know, look I need I need For example, you need to put more money in health care, you need to go in climate you know, you go

into education. And so the politics you know, of the post convict shock will be quite complicated. That's not the priority today. The priority today is to get out of this situation. But after it will not be easy. And between the Central Bank and the Ministry of Finance, it can be fined as long as inflation as well behaved.

And I think that's probably part of the good part of the good scenario, which has a high probability, and the central Bank put then But imagine, for example, imagining for example, things go much better and in the markets market people start to say, look, plenty of people, plenty of investors have bought you know, bonds and other you know, long term bonds at negative rates for a very long

period of long maturity. At some points, as you know, markets function, at some points when you will see you know, things improving, there will be a lot of people selling their positions and go to short, shorter term maturities. And when when you see that long term rates will increase. You have seen that in in the US following modestly you know, ten to fifteen basis points, you know, after

the announcement on the vaccine. But imagine you go to a situation when the vaccine it works, it's it's being you know, it's being given to a big part of the population and faster than what you expect so in the second half of next year, then there will be a lot of selling of government bonds because who wants to keep you know, a bound at minus fifty sixty basis points, And so that means that long term rates, as we have seen in this little episode in the US,

will go up, and then you will have to see, you know, at what point the central banks will intervene or not intervene in this normalization phase. I think it's a little bit too early to think too much about this, but the episode in the US, you know, two weeks ago with a vaccine, I think was precisely the sort of scenario I've in mind, you know, but that a bigger scale, and that the central bench should be prepared for that steepening of the yield curve. I think when

you have good news is absolutely not the problem. But as you see markets that tend to overshoot usually and a strong increase of rates, you know, in a normalization will not be welcome. As long as you don't have inflation. The central banks may intervene, but they have already they will have already twenty public that in their books. Are they going to buy another ten percent in their books?

Just to make the point. And I think this this Nobody wants really to talk too much about this because you know, the priority is not yet to think about this. But at some point we have to be prepared because you know, there is light at the end of the tunnel, as we say, and the trade it may it may be faster than some people think. So we have to

be prepared for all scenarios. And I I confess with you, I'm I'm worried about the normalization face, but also more fundamentally about the potential growth in Europe because normally it should go down and not. Now there's a little bit hope that you know, people get wiser, they will invest wise, and all these things. But that's not so much the lessons of the pense what we have seen in the Pense.

Let's let's hope for that. Well, just as a quick follow up to that point, I mean, one of the ideas that you here and you certainly hear it in the US and maybe implicitly through the FED new framework, is that there are benefits to running it hot and that okay, we we've we've uh FED sort of implicitly

has admitted that in the past. It's hip rates prematurely that it sort of was too aggressive to normalize rates and then had to reverse the rate hikes and uh come to mind, and and then the reversal in twenty nineteen. Are there benefits to running it hot? And what do

you feel about this debate? That it's like, Okay, let's let the economy grow, let's tolerate some more inflation, and that could engender the sort of investment that we need to see so that these uh declining trend growth rates and as you pointed out, even going into COVID growth potential growth rates were going down, that we might actually get a meaningful sustain reversal of these trends as opposed to just a temporary a temporary growth boom that then

reverse it again. That's an excellent important I mean, the intuition is it is readily simple that if if you're trying to stimulate and support demand and even create excess demand, firms are going to invest, you see, and and that would have an impact on supply side and you can have a sort of virtuous circle. Support of aggregate demand would follow the followed by you know, good supply side reaction.

My my, there is probably some point with this, I mean, there is always some truth into that, but I would I would warrant generally that the supply side depends of many other things like taxation, regulation, you know, the business environment, and if you support I mean, that's the more classical

view of that. And I think you know, in Europe, if you take the periods before we saw declining productivity in just before the financial crisis, you saw declining productivity growth in spite of high aggregate demands, you know, very strong aggregate demand. So I think it didn't work. I mean, you need to have a structural reforms, you know, to increase your potential growth. So I think there is some point you know, to that, but I would certainly not

say that this is a sufficient condition. The sufficient necessary condition is that you improve your your your your regulatory your taxation, your business you know environment if you really want to change you know, the potential growth. When I see the business environment, it doesn't exclude necessarily the state. You know, we know that public infrastructure can play an important role if it's well done, of course, and it's

it's a question of governments. But we immediately said it's not supporting aggregate demand that's going to make the trick. I think that's that would be an illusion again, and we have seen that in the past. I don't see reasons why that should be different in the future. So you need reforms again. And that's why I'm saying the normalization face. Don't forget. We aren't going to get back to the level of of pre pre COVID shock to the level not before well at best early twenty two.

Before we get to the level, that means there is a huge empoverishment compared to expectations of people. And that means that you know, at some point people were already complaining before in different countries about you know, their status, you know, the wealth evolution, the income evolution. These things will come back. This is not the priority today, but

these things will come back. So I think when we talk about institutions in Europe, it's absolutely essential, including the transfer we talk about that you have the mechanism of surveillance of the money which is being given, that it's efficiently used. Because if that is in place and things go down later on, you know you better have tested your new institutions on that. And there you know, you cannot be optimistic on that naively optimistic because the banking

union is not even achieved today. I think we don't have much time to do these reforms, and they have to be done in crisis actually, and I think it's understood by for the banking unions, certainly by the e c B pleading you know, for the Capital market Union and the banking union. But you need, you know, regulatory changes to do that, you need legal changes to do that, solvency loan and that, many things you have to do.

And when you see minis of finance, for example, their priority today is not ready to do that because they have to deal the shop now and coming with new regulatory changes, you know, tax changes for the future, completing the capital market union, the banking union. It's it's not the top priority you know, in the day to day life of politicians. They say, well, we'll see that a little bit later because now I have to manage the crisis. But when the crisis is finished, you will lack of

course of renewed institution. So I think this message is very well understood by the Central Bank, by the European Commission, by a number of minister of finance. If you look at Germany, they would absolutely approve a thing that's so reasoning that it's not that you have to change and improve, you know, institutions, the internal market, especially with the Brexit. You know, you have to do all this thing. You have to increase the co the political coesient, you know,

to deal with China. You know, the US will be a bit better, you know, in the international relations. But I think what we have seen in the US is a warning for the future. I mean, you know, it will not be as before, even with the new administration, it will not be as before. So Europe is to organize itself, doesn't have much time and they have to do it. No, but it's it's it's not easy. I mean for me it is so fine. It's because they have their short term priorities, which is normally Peter, that

was fantastic. That really appreciate you taking a time as a real trade to get here your perspective, and thank you for coming out. Thanks Peter, that was great. Bye, but okay, Moe bye bye bye. Yeah, that was a real treat. Tracy Peterson, he's I don't know if pessimistic it was the right word, but at no point did

he seem like particularly optimistic, did he? No? I think even in his sort of I mean, I think even in the what many people would say is the best case scenario where we do get a vaccine and things change very quickly, he seemed to lay out a very uncertain policy path in that case, the idea of a potential inflation overshoot or maybe markets getting royaled, like along the lines of what we saw a couple of weeks ago, when we have this big rotation from growth into value

and it was supposed to have broken a lot of quant models and things like that. It's not it's not what most people would focus on and when we're talking about the economic implications of a vaccine. But I do think he has a point. No, I mean, I guess, on on the one hand, I think it's good for public official central bankers just sort of maybe they should have a sort of slightly skeptical or pessimistic outlook because

they should be guarding against downside. But you know, just thinking about the issues he identified and his sort of skepticism that demands side policies would work, that there's much appetite to engage in reform outside of a crisis, which is another sort of recurring theme that we've talked about a few times. It's it's it's not great, but I mean,

I love I loved this perspective. Obviously, I love hearing it. Yeah, absolutely, And it was interesting to hear him reminisce a little bit about, um, what was going on at the e c V during some pretty famous times, like during Mario jogs whatever it takes moment. Yeah, I mean, he's sort of it's it's interesting. It's fairly diploma attic, and obviously most central bankers are pretty good at diplomacy. But one has questions about how annoying the Germans were when it

came to physical transfer. I just say, uh, he um, there must have been some pretty tense moments in the behind closed doors between uh, the sort of the Germanic view of central banking versus everyone else who wanted to get things moving along. That's that's also a diplomatic way of putting it. Yeah, exactly, well, man, this is my audition to be a central banker one day that I can that I could describe things like that at up word okay, um on that note, shall we leave it there? Sure,

let's leave it there, all right? This has been another episode of the ad Thoughts Podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Why Isn't Thal. You can follow me on Twitter at The Stalwart. Follow our producer Laura Carlston. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesco Levi at Francesco Today, and check out all of our podcasts under the handle at podcast. Thanks for listening.