Interview with Athanasios Orphanides, Governor of the Central Bank of Cyprus, conducted on 11 February 2010 by Gabi Thesing
On Greek crisis:
I view the statement by the heads of states of the European Union that was issued yesterday as very positive.
The ECB expects and trusts that the Greek government will take all the necessary steps to get its public finances in order. Measures that the Greek government is already in the process of implementing are steps in the right direction.
I welcome Prime Minister Papandreou's stated resolve to do whatever is necessary, including taking additional measures if needed, to follow through with the deficit reduction plan.
Regarding the question about markets, I consider it futile to interpret every single movement in financial markets. Sometimes markets experience overreactions that do not necessarily reflect macroeconomic fundamentals. There may be divergences in views. The markets show remarkably high spreads at the moment on Greek debt and yet the only thing I can state is my personal view that default of a euro area sovereign is unthinkable.
If you want to count me among the optimists, count me among the optimists. I trust that the perseverance of the Greek people and the determination of the Greek government will prevail.
On Ireland as an example for adjustment:
I see very positively the adjustments that were announced by the Irish government in December and I think that they set a very good example that other governments in the euro area should be following, as necessary in each individual case, in order to set their public finances in order.
On exit:
In terms of the phasing out of unconventional measures, the key is what has already been stated by the Governing Council. In the current context, we will continue our enhanced credit support to the banking system. But at the same time we take into account the ongoing conditions in financial markets and the banking sector.
Looking at financial market conditions I think it would be indisputable that we have had over the past several months a continued improvement and it is for that reason that the Governing Council took the decision of a gradual phasing out of some of the liquidity measures that are not needed to the same extent as in the past. This is as true today as it was a month ago or two months ago, and I think we can continue along the same principles.
On continuation of phasing out unconventional measures:
Conditions in money markets have improved. So there is much less need for all the unconventional monetary policy measures. Under the circumstances, in a cautious way, we will continue with the removal of the unconventional measures that are not needed to the same degree.
In terms of details, on March 4th there will be a discussion of continuation of phasing out of unconventional measures.
In general terms, the natural progression is to shorten the maturity of liquidity provision, while ensuring that ample levels of liquidity remain in the system. Once this is done, we will then examine whether we should continue and at what pace we withdraw some of that liquidity.
This is the strategy that is already in place, reflected for example in the discontinuation of the 12 month and 6 month operation. I note that the operations still remaining, the 3 month, the 1 month and the MRO operations, are the standard ECB operations.
Return to tenders in REFIS:
This is a harder question to assess. In the circumstances we are in at present, with very low short term nominal interest rates, it's very hard to assess precisely what the demand for liquidity in the banking sector is.
For that reason it is entirely sensible to have a procedure that can flexibly meet variations in the demand for liquidity and that is what our fixed rate/full allotment policy is doing.
As long as there is continued uncertainty about the demand for reserves in the banking system, it's sensible to supply ample liquidity in the system in order to avoid any undesirable fluctuations in market rates.
Details will be discussed in the governing council. I do not wish to pre-empt the discussion.
On concern that the end of the June LTRO will disrupt markets:
We are very sensitive to the expiration of the first 12-month LTRO.
We will ensure that measures will be taken to smooth out the transition from that particular LTRO without creating disruptions in markets. Banks should be able to obtain short-term liquidity as needed when that LTRO expires.
We wish to be very prudent and cautious in the phasing out of the unconventional measures we have right now. All of our decisions will be consistent with prudence and continued caution.
On speculation there may be second 6 month tender in June:
The Governing council has already stated that the next six month operation will be the last one.
On interest rates:
Assessing the appropriate degree of accommodation is a function of the risks to our price stability objective.
Inflation at the moment is below our definition of price stability which confirms the appropriateness of continuing with an accommodative monetary policy stance.
The phasing out of some unconventional measures should not be misinterpreted as a desire to remove policy accommodation from the economy. Policy accommodation continues to be needed, in light of the very subdued inflation outlook and the unevenness and weakness of the economy.
I consider the degree of policy accommodation that is reflected in various money market rates at the moment as being appropriate.
On whether the ECB is debating to raise the deposit rate to lift EONIA toward the benchmark:
If you are asking me whether it would be currently appropriate to start removing policy accommodation, the most important element in my view is to be symmetrical in our pursuit of the price stability objective.
Looking at recent inflation outcomes being considerably below 2 percent and the inflation outlook continuing to be subdued, I view the degree of accommodation that is currently reflected in our policy as appropriate.
On market forecasts that the ECB will raise rates in the fourth quarter:
I don't find it helpful to try to forecast interest rate moves well into the future. What is more helpful is to understand the determinants that are the key and will help us make such considerations in the future.
Going forward, the evolution of the economy, and the associated risks to price stability, according to our definition, are the key issues. If events over the next several months are consistent with inflation remaining subdued and considerably below our price stability objective, that would indicate that the accommodative policy should remain in place.
If, on the other hand, we are positively surprised with stronger growth in the economy and a pickup in inflation that would bring it closer to our definition of price stability, that would suggest the need for a tightening of policy. In light of this sensitivity of the policy decisions to the evolution of the outlook, I do not consider it very useful to forecast policy rates.
On SPF which lowered 2011 inflation forecast:
The reaffirmation that on average, the five year inflation expectations remain at 1.9 percent, is a very positive outcome of the survey which reconfirms the ECB's success in maintaining well anchored inflation expectations in the medium to longer term.
With that in mind, turning to the shorter term inflation expectations which for 2011 was revised down to 1.5 percent from 1.6 percent, I had observed last November that the 1.6 percent reading at the time was the lowest year-after-next reading in the history of the survey. I would have been more comfortable if, reflecting an improved economic outlook, inflation expectations for 2011 moved closer to our definition of price stability rather than a little bit further away from it.
I am concerned that if HICP inflation stays significantly below our definition of price stability for an extended period, this deviation could become embedded in longer term inflation expectations and risk unanchoring inflation expectations to the downside. This would be an unwelcome development, in my view, and indeed I am concerned about it.
On the state of the economy, Q4 euro area GDP at 0.1 percent:
The latest reading on GDP was a little bit weaker than the baseline scenario. That said, all along we have been sensitive to the fragility of the recovery in the euro area. The ECB has been more cautious than numerous forecasters in noting the fragility of the economy and noting that the recovery could still be bumpy.
We are monitoring the improvement in the economy overall, but at the same time we also note the weakness in the money figures as well as the weakness in credit growth. Those are in my view consistent with the recovery not being very strong at the moment.
On the risk of a double dip recession:
It could never be excluded but I am optimistic that we will have continued, albeit gradual growth in the euro area as a whole. The bumpiness should also be considered together with the heterogeneity of the recovery in different areas. In some countries of the euro area the recovery that is under way right now is actually nicely strong, whereas in other countries we still have not had recovery.
On whether deflation risks are banished:
Confidence has improved in the euro area and we are clearly beyond the worst point in the downturn. I don't really see the prospect of deflation risks at the present being anywhere close to those of last spring when the economy was in freefall.
On how much impact fiscal tightening will have on euro area growth:
In terms of longer term growth, I think we are at a point where in most euro area countries the path towards fiscal consolidation is absolutely essential in order to ensure that, going forward, we will have favourable medium and long term interest rates in order to promote private investment and productivity.
Dealing with the large fiscal imbalances in a number of euro area countries would not dampen but would promote growth.
Cyprus questions:
On whether Cyprus is heading for Greece-style crisis:
Indeed, the deterioration of the fiscal finances we have experienced recently in Cyprus is very unpleasant. The government should take the appropriate steps to tackle it as quickly as possible, precisely to avoid a further deterioration that would have adverse longer-term consequences for our economy. That said, I should point out that the budget deficit estimate for 2009 puts Cyprus in the middle of the range for the euro area as a whole. The situation is clearly not as dire as in some other euro area countries. To some degree this is because the recession we experienced in 2009 was not as deep as in other regions of the euro area.
A comparison with the Greek economy is not warranted. Our budget finances are in better shape and our debt to GDP ratio is considerably smaller.
On whether consolidation includes cutting public sector cuts:
The growth of government expenditure that has been experienced over the last number of years cannot continue and must be curtailed. Control of government expenditure should be an important component of the fiscal consolidation process.
It is crystal clear that there is a need for corrective fiscal consolidation in order to avoid further deterioration, especially since the growth prospects for the Cypriot economy in 2010 are somewhat lower than the growth prospects for the euro area as a whole.
What we have seen in Cyprus is some delay in experiencing the consequences of the crisis relative to the euro area and it seems likely there will be some delay in returning to growth in the economy as well.
On IMF proposals to lift inflation targets to 4%:
I think the proposal that central banks should start targeting an inflation rate as high as 4 percent, to reduce the problems associated with interest rates being stuck at zero, is a most unfortunate suggestion.
If there is one thing I strongly believe we have learned over the past 50 years is how important it is for central banks to preserve price stability because price stability is the best contribution monetary policy can make to growth and welfare over time.
The suggestion that we face severe difficulties in expanding monetary policy when interest rates are very close to zero is incorrect.
I believe the crisis management we have experienced over the last couple of years, when a number of major central banks have adopted a range of unconventional measures to ease monetary policy and avert the threat of deflation, convincingly show that we have the tools that are necessary to preserve price stability and avert deflation under the circumstances.
I see absolutely no reason to tolerate corrosive, higher inflation in order to reduce the probability that policy rates may occasionally have to be very close to zero.
The mere suggestion that we should change our current framework in central banking toward the adoption of higher inflation targets is counter productive as it may weaken the hard-fought achievement of anchoring inflation expectations at a sufficiently low level of inflation which could be viewed as effective price stability.