Interview with Athanasios Orphanides, Governor of the Central Bank of Cyprus, conducted on 11 April 2009 by Gabi Thesing, published on 14 April 2009
On monetary policy in the coming months:
I believe it is very important that we remain true to our price stability mandate. If inflation threatens to remain significantly below 2 percent for a considerable time, then additional policy easing could be warranted to counter that eventuality.
On interest rates:
As President Trichet stated after our last policy meeting, the current rate is not the lowest limit. The President also said we are never pre-committed. We decide what is most appropriate at every policy meeting.
In my view, in the current context both the refinancing rate and the deposit rate are important for the transmission of monetary policy.
Because of the unlimited provision of liquidity I would say that they are currently the most important policy rates.
They serve different purposes and both contribute to the transmission of monetary policy decisions to other interest rates and the economy.
What is important to keep in mind is that as policy rates get close to the zero lower bound, they may no longer suffice as the best indicators of the stance of monetary policy and of how expansionary monetary policy may be.
In these circumstances it becomes, in my view, quite informative to focus greater attention on other interest rates that are not as close to the zero lower bound.
Let me draw your attention to the interbank money market. The six- and 12-month euro rates are currently lower than the equivalent dollar rates. And I would note that this is despite the fact that the Federal Reserve policy rates are considerably lower than the ECB policy rates.
Since Oct. 8, the key ECB policy rates have been cut by 300 basis points. Since mid-October, we have observed a decline in the three-month euribor of about 400 basis points. This reflects not only the reduction of the ECB policy rates but also increased confidence in the banking market, which is of utmost importance for our economy.
In my view, at the moment, the effectiveness of additional monetary policy easing may be easier to ascertain with the evolution of these money-market rates. It may be more useful to look at the constellation of these rates, rather than at any one particular policy rate.
Additional policy measures, if and when they are deemed appropriate, can further reduce these important money-market rates.
The decline in money-market rates was triggered by the whole policy package, including non-standard measures. It is important to look at the whole policy package in the current situation. The ECB has been in non-standard mode for quite some time.
On non-standard measures:
Asked if an asset-purchase program could be announced after the May meeting:
We cannot rule anything out.
We need to remain open and flexible. We do not have the historical experience that could help us calibrate very well what the best suited unconventional measures for the euro area may be. In this sense, this is not the easiest discussion to have.
One option is extending the maturities of the long-term refinancing operations we are already engaged in. Other options would be purchases of various assets. At present, the aim is to identify what is the best way to proceed for the Eurosystem.
I do not want to pre-judge our discussion at the next policy meeting. Things are under discussion, a very open discussion, and we always strive to reach the best decision for the euro area.
On why the ECB could engage in asset purchases even though the economy is predominantly bank financed:
All asset markets are interconnected. The alternative financing opportunities that may be available to businesses and households are interconnected. Bank lending rates are influenced by the money market but what a corporation has available for its financing needs will depend on both what bank lending rates are doing and also on other rates in the commercial paper or corporate bond market.
On whether the ECB would have to cut the benchmark rate to zero before embarking on asset purchases:
We find ourselves in very unusual circumstances. I note that we had already embarked on non-standard measures when the main policy rate was much higher than it is today. Since we are already in non-standard mode, further expansion of the menu of non-standard measures we implement should be seen as part of the total monetary policy package we have.
On how the ECB would finance these measures:
Non-standard measures typically involve operations with a central bank’s balance sheet. If an expansion of the balance sheet is needed for some non-standard measures then this is what will materialize.
On extending the maturities of loans to banks:
In the current context I could see extending the maturities to up to 12 months as a natural extension of the framework we already have in place. Beyond that I would not like to comment on the several options that are under consideration.
In my view, what is most important in the unlimited provision of liquidity at longer maturities is the fact that we can assure banks in the euro area that they do not need to worry about sudden shortfalls in their liquidity planning for many months going forward. They can be certain they can obtain liquidity from the Eurosystem at very low rates, provided they have eligible collateral.
I do not attach particular attention to short-term fluctuations in the actual quantity that is being drawn on it.
On whether the ECB would need to flag that the benchmark rate has reached its lower limit:
I think at the low rates we have we should look at the whole package of policy measures we have taken and not attach particular emphasis on any particular rate.
On the rate corridor:
The difference between the main refinancing rate and the deposit rate is one of the inducements to activity in money markets. The re-widening of the corridor has been a factor behind the improvements we have seen in the money markets. That is one of the positives.
At the same time, as the policy rates are approaching zero I can envision a situation where it would be appropriate to cut the refinancing rate to such an extent that would be inconsistent with the current size of the corridor.
The deposit rate cannot fall much further.
On claims that the ECB is behind the curve:
Some claim that the ECB has done less than other central banks. I don’t think it’s fair to say that the ECB has done less than what would be appropriate or that it has been less creative.
In terms of the degree of policy accommodation, what matters is the end result. And as I have indicated earlier one set of indicators one can look at is the rates at various maturities in the money market. Looking at the euro rates, I believe that one could even characterize the ECB policy as more accommodative in some respects than what the equivalent measures would suggest for some other currencies.
Even if we look at non-standard measures we should recall that the ECB has expanded its balance sheet quite a lot since the beginning of the turmoil.
We have strong indications that the policy easing is feeding through to the economy. When trying to compare policy measures of different economies and their outcome one should bear in mind that there are differences in the structure of the economy and the transmission process.
In Europe for example, in contrast to the U.S., banks are much more important for the transmission of monetary policy to the economy. This is one of the crucial reasons why the monetary policy easing we have been pursuing has been bank-centric.
We have observed in the last few months that lending rates have fallen significantly in the euro area on average, although there are differences from region to region.
On declining credit flows:
The issue with the credit flow is a harder one to judge because one needs to assess the evolution of the demand for credit and the supply of credit.
It’s always difficult to separate the effects of the demand from the effects of supply, when we observe a quantity of credit changing. In my view, we have seen in the past few months a notable reduction in the demand for credit, which is to be expected in light of the decline in economic activity.
That being said, I do believe that credit standards have become somewhat tighter as well.
On tighter credit standards:
I do not think what we have observed in the euro area could be characterized as a credit crunch. It should be expected in the current circumstances that we would observe some tightening in credit standards, reflecting in part the fact that economic conditions are much riskier. It’s proper and prudent that banks have become more careful in their lending standards.
On the economic outlook:
There is no denying that we are living through a severe synchronized economic downturn throughout the world and there is considerable uncertainty about the future.
Policymakers around the world have recognized the severity of the situation and they have taken bold measures that I am confident are helping to get us out of the crisis.
On the ECB staff projections:
The incoming information since the ECB staff finalized its March forecasts appears to suggest some additional weakness in the euro-area economy.
I believe this is one of the reasons why some of the more recent forecasts by other organizations, including the IMF and the OECD, have been more pessimistic.
The situation continues to be characterized by great uncertainty.
On the possibility of a recovery in 2010:
A recovery sometime during 2010 is not an unrealistic baseline scenario to have. This baseline scenario is consistent with forecasts by other organizations.
On the inflation outlook:
In light of the recent additional information I would say that the risk of deflation has increased somewhat in the past few months. However, in the euro area the risk of a protracted fall in prices remains rather small in my view.
It is likely, however, that owing to the dramatic swing in commodity prices, we will see small negative inflation readings in the coming months. These readings should return to positive levels after a few months.
The weakness of worldwide demand in recent months is likely to exert downward pressure on inflation, not only for this year, but also for next year and maybe beyond that, depending on the outlook for the economy.
This is one of the reasons why it is important to carefully monitor inflation expectations going forward. A protracted period of inflation below our definition of price stability could risk unanchoring inflation expectations, thereby increasing the risk of deflation. I will study with interest the results of the next survey of professional forecasters which will give us a new reading for inflation expectations before our next policy meeting.
On whether global stimulus packages pose inflation risks:
The ECB can and will do what is necessary to maintain price stability in the euro area. This is our mandate. I am confident that we can achieve this regardless of whether there are other areas in the world that do not manage to maintain price stability as solidly.
With regard to central banks in the industrialized world, I have full confidence that they will take the appropriate action to maintain price stability in the long run.
The importance of price stability is much better understood now than in the past.
On whether the ECB will have to raise rates quickly when the economy recovers:
In our policy framework, the evolution of inflation and inflation expectations provide a useful guide. If the economy recovers and growth materializes faster than anticipated and inflation risks emerge, then most certainly monetary policy will have to be appropriately tightened.
On whether the council is split:
It is perfectly true that economic fluctuations have been different in different regions of the euro area. This is no different than what is observed in other large economies such as the U.S. where regional and sectoral differences are also evident.
At the Governing Council we take decisions for the euro area as a whole. I would challenge claims that the Governing Council is divided. What I would admit to is that there are open-minded discussions about what the best way to proceed is, about identifying the best monetary policy for the euro area. This is to be expected in a committee setting and in these very challenging times when the historical precedent on its own does not provide very good guidance.
It’s to be expected that there will be constructive discussions reflecting a diversity of views before the committee reaches a consensus decision.
On the differences between the ECB and the Fed:
The structure of the two institutions is similar. The similarities are greater than the differences. There is one important difference and that is the clarity of the mandate of the ECB, which makes arriving at the right policy decisions much easier, in my view.