Even behind a Zoom video connection, Peter Praet is still the speech waterfall he has always been. He effortlessly meanders from the constitutional court in Karlsruhe to the Italian tradition of parliamentary uprising and the balance sheet of the ECB. Halfway through an explanation of state guarantees for bank loans, the video image suddenly freezes. When it resumes 15 seconds later, he already appears to be completing an analysis of the European venture capital market.
All kinds of things are moving simultaneously in these exceptional times. Even for a formerly seasoned central banker, who makes simulations for all possible economic scenarios – stress tests are called something like that – what is happening now is unseen. Praet therefore does not attach too much importance to the precise assessment of damage in the short term. “We know that the shock will be phenomenal. I estimate that gross domestic product will fall by 10 percent in the eurozone this year. But the question that mainly concerns me is what that means in the long term. “
“I think we need at least two years to get our GDP back to the 2019 level,” he continues. “A large part of the public does not yet feel it because it still has its job, is temporarily unemployed, is a civil servant or is retiring. But there has been an immense gap between our income, which has so far remained fairly stable, and our production, which has collapsed. “
Who will pay the bill?
Peter Praet: “I especially notice that politicians everywhere in Europe are avoiding that question. And I understand why. When the population understands that taxes will rise, they become more cautious about spending money. “
“For that reason alone, I never believed in a V-shaped recovery. Not even because of the danger of the virus reviving. But because once the economy recovers, the tension about who pays the bill will grow. “
“You also notice that in the recovery plan of 500 billion euros that German Chancellor Angela Merkel and French President Emmanuel Macron have proposed this week. We do not yet know who will pay what and how it will be done. Some speak of eco-taxes, but that too is a discussion for later. “
As the population understands that taxes will rise, they become more cautious about spending money.
But again: who will pay?
Praet: “You can reduce expenditure, but there is just a demand for more expenditure to fight the pandemic, finance health care and keep social security strong. You can increase taxes, which has negative consequences for growth. And that leads you to the question of what role the central banks will play. “
Some find there a reason for optimism. Let the state borrow money at the zero rates set by the central banks. It costs nothing.
Praet: “That certainly makes it easier. But don’t forget that the economic situation was difficult at the end of last year. Also, do not forget that the ECB is currently pursuing an emergency policy to combat the pandemic and is therefore short-term. Meanwhile, it appears that this shock continues to resonate longer. “
“Moreover, there is a difference with the past ten years. Then the governments did too little and the ECB felt “the only game in town”. Now the governments are doing a lot to fight the crisis. Look again at Merkel and Macron’s recovery plan. Besides, I think the Commission will propose to increase that EUR 500 billion. ”
“If governments borrow billions and have to continue to do so because the crisis continues, how will it work? Then those debts might become very expensive again. To what extent can a central bank compensate for this increase in government debt through its interest rate policy, while at the same time keeping prices stable? It is not as easy as it seems. “
That is one of the major economic questions. Are we on the brink of an era of hyperinflation? Or just deflation, in which prices drop because nobody comes to the store?
Today we are in the same boat with our European family, even if not everyone in your family is as you want.
Praet: “Your question is too early. The deflationary effects of the shock dominate for the first two years. But then inevitably comes the question of what the political world will do when the bill comes on the table. Will she then defy social and political tensions and dare to go to parliament to look for money? Or will it avoid that and aim for the central bank to solve it with a bit of inflation: a growth of 1 percent and an inflation of around 4 percent, as a result of which the real value of the debts falls annually? That’s about what happened after World War II. It is an inflation tax, but people feel it less than a real tax. Economists call this “money illusion”. But it is not that easy. It can easily go off the rails in uncontrollable hyperinflation.
How should the ECB deal with this?
Praet: “By currently focusing on today’s main concern. That is not hyperinflation, but deflation: falling prices because the activity is so low. At the same time, it must make clear to the political world that it will never tolerate any “inflation tax”. So she has to make clear how she will eventually step out of her temporary “whatever it takes” emergency policy. “
That is already a discussion. The German Constitutional Court in Karlsruhe this month did not just agree with the way the ECB conducts its extremely flexible policy.
Praet: “That, together with Merkel’s speech, was one of the two important moments of this month. I have read the 110 pages of the judgment, also in German. The European treaties state that European decisions must be proportional. They should not be heavier than what is needed. In the interpretation of the judges in Karlsruhe you therefore have to make a cost-benefit analysis. “
“It is difficult to accept for the ECB. Because how do you weigh the costs and benefits if you have a mandate under the treaty to keep inflation under control first and foremost? What, then, are the acceptable costs of that inflation policy, measured in jobs or financial stability? That almost pushes the ECB into an impossible situation. “
Is the eurozone strong enough to withstand this storm? The difference between Germany and Italy, both in terms of damage and recovery potential, is immense.
Praet: “That is the most difficult problem at the moment. Where inequalities in countries lead to tensions, this will also lead to tensions between countries. That’s why I thought what Merkel and Macron propose was visionary and a very nice signal. “
“It is a big step. Germany has built up a buffer for itself in recent years to take the next shock and Merkel now has to explain that the money saved is partly going to the rest of Europe. I can understand that many Germans are not satisfied. But today we are in the same boat with our family, even though not everyone in your family is the way you want. “
That shows how severe this economic storm is, yet the stock markets continue to do quite well. Do you think the gap between markets and reality is too large?
Praet: “They are certainly so high in the US because of the support policies of the central banks, because of the preponderance of the tech companies and because of the confidence in a vaccine. But the gap with reality does indeed seem too big to me. “
“That is not bad, of course. It is good that wealthier people are putting their money in risk capital through the stock market. But the valuations seem particularly high to me, especially in the US. “