The worst crisis since 1929, says ex-ECB board member

Otmar Issing was between 1999 and June 2006 member of the Executive Board of the European Central Bank (ECB). As its chief economist, he was regarded to be one of the most influentual board members. Issing descibes the current crisis as “ the worst crisis since 1929, one which will have many consequences. What is extremely dangerous is the loss of confidence which goes on.” One cause of the crisis is the long period of low central bank interest rates, says Issing.

Euro area is lucky to have the euro, says Issing, otherwise things would probably been even worse. “The single currency has also made the euro area financial markets much more shock resistant. Imagine for a moment what would have happened in the course of the last 12 months if we still have had all those national currencies.” 

The former ECB-board member, but also between 1990 en 1998 member of the board of the German Bundesbank, is nowadays, among other things, international advisor of Goldman Sachs. FEM talked to him recently in Goldman Sachs office, on the 60th floor of the Frankfurter Messeturm.

What would have happened if we still have had all those national currencies in Europe?

“The same crisis in the exchange rate markets we have seen in 1992 and 1993. Then there was speculation against some European currencies, and central banks had to intervene heavily. If Europe still had had national currencies, I think the European exchange rate system would have collapsed. That could have endangered the whole single market. In 1992 the Italian lira was devalued against the German mark, in a short period of time, by more than 30 percent. That meant that immediately some companies in Germany, for which Italy was the most important market, went bankrupt. They simply could not cope with such a sudden change in price competitiveness due to the strong appreciation of the exchange rate. This benefit of a single currency in the euro area is the benefit that largely goes unnoticed, because it is one of the issues in the always difficult discussion ‘what would have happened’. The single currency has saved the euro area financial markets quite a lot.”  

You are known to be a central banker who is above average anti-inflation. The inflation rate in the euro area now stands at around 4 percent. Does that worry you?

“Inflation hurts the weakest members of society the most. That is the most important reason to be anti-inflation. The ECB has always taken its task of preserving price stability seriously and it will continue to do so. In the context of strongly rising energy and food prices, the inflation in the euro area has exploded. This is a big concern for every central bank and the ECB in particular. President Trichet has made it very clear that it is of the utmost importance to have inflationary expectations well anchored at levels consistent with the mandate. Against the direct impact of rising energy and food prices on the cost of living, the central bank can do nothing. Remember when the ECB started operating the oil price was around 10 dollar. The central bank can do nothing about that. But it must do everything to avoid that second round effects translate these one-off price increases into inflation.” 

Do you see those second round effects emerging?

“If you compare the current period with the seventies, there is a big difference. Back then wage growth exploded, which was the main reason why then we have seen a decade of high inflation worldwide. One of the major explanations why this time even with stronger oil price increases inflation is still much more moderate is the fact that inflation expectations remain anchored. But that is not a given, central banks have to work for that trust and convince markets and people that this increase in prices is temporary. One cannot deny that inflation expectations have risen somewhat but they are still under control. But this story is not yet over.” 

The key ECB interest rate now stand at 4,25 percent. Is that high enough to combat inflation, given the fact that the inflation rate in the euro area is around 4 percent?

“I am an economist but I am also a former member of the ECB board and as such I never comment on current monetary policy. For me, it is clear that a former central banker never should comment on current policy, it would only make the life of your colleagues, which is difficult enough, even more difficult.”  

Note from FEM: In the meantime, on October 8th the ECB, together with other important central banks has cut its key interest rate by 0,5 percent.  

In recent weeks the euro has been declining against the dollar. Could you shed some light on how the changes in the exchange rate of the euro enter the debate at the ECB’s Governing Council?

“The exchange rate is an important variable that the ECB takes into account. It is however not a target and it will never be one. It plays an important role in the forecasts on inflation and economic growth the staff makes at the ECB. The exchange rate used in those forecasts is not their forecast, but simply the average of the last ten days before the forecast was finalized. If you talk about risks to inflation, the exchange rate plays a major role. The appreciation of the exchange rate in the past has dampened the inflationary impact of rising energy prices in the euro area.”  

Will the recent euro decline fuel inflation in 2009 and 2010?

“The exchange rate assumption of the ECB staff in the latest projections was 1,53. Since then the euro has declined further. That will have an impact on inflation and growth going forward. But other factors as falling oil process will also play a role.”

Read also our interview with Paul Volcker, legendary chairman of the Federal Reserve Board.

Reactie(1)

ben g 13-10-2008 21:45

Ik hoor heel wat economen roepen dat deze crisis de ergste is sinds 1929, maar het zijn vaak allemaal onbekende economen waarvan ik me afvraag hoeveel waarde ik moet hechten aan hun woorden. ALs ik dan Issing dat in fem business hoor zeggen, dan wordt het een ander verhaal.

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