 Welcome to the European Central Bank podcast, bringing you insights into the world of economics and central banking. My name is Michael Steen, and in today's episode we will cover the impact of coronavirus on the economy. Now I say the economy, as that's our focus at the ECB, but it's worth taking a moment to reflect that this is a gruesome disease with a spiralling death toll. Each one of those numbers that updates daily represents a tragedy for the families and friends of those who died. To try to keep everyone safe, many of us have been urged to stay at home, that's had some fairly stark effects on the economy. People are buying less, companies are producing less, whole sectors have just come to a stop. People have lost jobs, or have greater uncertainty about their jobs. In this episode we are trying to understand the economic impact of the coronavirus pandemic and the ECB's response to it. We're joined by ECB Executive Board Member and Chief Economist, Philip Lane. Philip, thanks a lot for being with us. Good morning. Now this is a bit of a peculiar setup of course. I'm at my desk at home just outside Frankfurt and you're in Dublin I believe. Where are you and how are you doing? So for the last few weeks I've been working from home. As you know the Executive Board has been working on a split team basis, so in these weeks I've worked from home. So far that has turned out okay. I think the ECB is built on a lot of teamwork and I suppose my observation is if that teamwork has already been in place, so now it's nearly a year since I joined the ECB. So if you know the people very well then the fact that the day-to-day meetings are over the internet over the phone line is okay because you already know if you like the people you're talking with, we can work quite effectively at least for a while from home. That's the philosophy behind how the board is working. Well to start off with let's maybe talk a bit about the economy as a whole and how the coronavirus pandemic has affected it. What are your observations? Here we are now, here we are at mid-May, it's probably at the very bottom of the economic impact of the virus. So of course China in the first few weeks of 2020 had a big hit. We've seen China now starting to recover a little bit. But for the European economy in some countries it's early March, for more countries it's mid-March when the severe restrictions came into play. And only now in the middle of May is there some relaxation. So in these weeks where a lot of if you like face-to-face economic activity has been restricted, this has been a really spectacular decline in economic activity, it's very hard to look backwards and find previous examples because sometimes people say oh this is like the Great Depression. It's not in the sense of the week by week decline in economic activity is more rapid this time but under the hand we do know as the restrictions are lifted not going back to the old normal but some level of recovery in economic activity can be expected. But if you like everyone who's looking at the European economy, the world economy is agreeing that right now at the second quarter of 2020 will be the bottom and then in the coming weeks and months we will have some recovery. But the big open question is how quickly will that recovery happen over what time period because I think we can all agree that what we expect now is social distancing and also the personal attitudes to economic activity are going to remain subdued until the vaccine is found. So it's not just a case of lifting the severe restrictions. It's also a case of working out how to adapt how we do business, how we consume, how we invest over the coming months. Okay and that's a bit this concept of the new normal right so when we go back but it's not like what it was before exactly at least for the time being. Right I think there's two sides on the supply side. It does make it more difficult to conduct normal economic life. So every day you can read about how offices have to be reconfigured, how shopping has to be reconfigured and then when you think about global supply chains even just the coordination issue which is around the world a given city might be ready but it's reliant on inputs from somewhere else in the world. And then on the demand side the question is when will people feel comfortable for example taking a vacation? When will people feel comfortable going to a restaurant? So there's many open questions there and then on investment it's not exactly the conditions under which firms will want to commit to large scale projects given all of the uncertainty. Okay we've clearly had a lot of bad news recently hospitals and healthcare workers have been struggling in some countries to deal with the crisis so called key workers in public transportation or the food industry have carried on working. Now you mentioned this very dramatic decline we've seen caused by essentially a sudden stop for big parts of the economy so which sectors in the Euro area have been or will be hit the most would you say? Well I think the key characteristic is really the face-to-face element because of course as we all have discovered you can do a certain amount of economic activity remotely through the internet whether that's as we just talked about organizations producing services in particular remotely but of course you can also do to a degree online shopping but that doesn't really work for tourism it's very big sector it doesn't work for transportation so whether that's personal travel business travel it doesn't work for that it doesn't work for hotels so that whole sector of trade transport food services has been hit. Entertainment you know that's a big part of in a high income society an important part of economic activity is arts entertainment recreation sports and so on that's been hit a lot. For a while construction halted in a lot of places even though that's one of the first sectors to recover. Manufacturing as we mentioned that if you're in an industry where essentially either you're waiting for vital inputs to arrive you may not be able to produce but of course also when you're producing highly valuable goods where there's a limit to how much you can stock them up and for sale later on then the fact that it's just impossible for example nearly impossible to sell cars for example in this environment then then the car factories have to have to pause to a good degree so you know there's a lot going on. Okay so if we turn to the policy response I mean we've seen a lot of measures already taken governments introducing guarantees and that kind of thing. Fiscal responses we've had responses at the European level and also at the national level but if we look at the ECB what is what is our role in this crisis and exactly how does monetary policy or how can monetary policy help here? So it's a very special situation where monetary policy is vitally important in a fundamentally different way to normal. Most of the time and if you go back two or three months our kind of focus was how do we provide the monetary policy to help inflation recover towards our aim of close to 2%. So that's the normal focus of monetary policy it's about delivering price stability. Now with this shock when it came along there were two big issues. One when you have a dramatic downturn in the economy that threatens price stability because of course a very large reversal in the economy is also a situation where disinflation pressures are likely. So we have to respond to that. A second issue of course is in a situation where there's a lot of lost revenue. Many firms have lost revenue for a few weeks or months. There's a big demand for liquidity because of course a firm that was in good shape at the very least may need to borrow for a few weeks to maintain cash flow. So liquidity needs went up a lot and third this is a really large shock in financial markets. So if you like the normal activities of debt markets in particular are interrupted when you have to revise your beliefs about the world in such a big way. So the ECB if you like on those three fronts one is in terms of the funding conditions in the economy that the part of interest rates. Two is in terms of liquidity and three is in terms of market stabilization. So whether it's the ECB or the other major central banks we've been extremely busy to address those issues essentially through very large liquidity operations with our flagship targeted lending program through stepping up of our asset purchases especially through the new pandemic emergency purchase program the PEP and also which really serves two functions. One is to stabilize at the securities markets. So whether that's commercial paper, corporate debt, sovereign debt does a stabilization role but also in a world where the interest rate is already very low. It's our main way to keep the path of interest rates. Short-term rates, medium-term rates, long-term rates low enough to provide the conditions under which households and firms can obtain funding at a reasonable rate. So that's the playbook and let me emphasize this is all in the context of a remarkable role for fiscal policy. The lessons from a previous large shocks, the great depression and so on is that it's very important that the shock is not compounded by for example a loss of household income. So what we've seen is governments around the world stepping in with large transfer programs whether that's unemployment payments or payments to firms to help meet their payroll costs and so this has really has been very dramatic period for fiscal policy and for monetary policy. Okay and the two things are crucial to go together because the monetary policy is not going to... Yes sorry go ahead. Sorry yeah so the the idea that they go together it's very important to make this point especially when you know we often talk about central bank independence is this large shock is independently calling for a very responsive monetary policy and a very responsive fiscal policy. So it's essentially the situation does call for a lot of policy action on both fronts. Essentially that almost the definition of liquidity it bridges a gap but the ultimate hit on firms on households has to be met by fiscal policy. Central banks on their own can only do so much so there's an absolutely central role for fiscal policy. What's also true is the effectiveness of fiscal policy would be less if the liquidity provision and the interest rate policy of central banks did not respond to this shock. Okay and if we just go a little bit deeper into those two big responses by the ECB so we've got the pandemic emergency purchase program which is asset purchases or a form of QE that we've added and then on the other hand we've got the targeted lending operations the targeted longer-term refinancing operations or teltrose in the jargon. So if we just look at the first one the the pandemic emergency purchase program the PEP that that's of the three things that you mentioned that if I if I'm understanding you correctly that's to target two of those contingencies it's basic one big part is this idea of calming financial markets but the other big one is dealing with this disinflationary hit that's caused by the the sudden stop to economic activity. Is that a good summary or are you probably going to correct me? Exactly so it plays that a double role by the way did they go together the kind of a market stabilization problem would be more severe if interest rates were higher and but equally if the market stabilization was not handled then then the impact on risk premia on market frictions and so on would push interest rates up so they go together and this is why maybe it's not too easy for someone trying to understand PEP to have an exact if you like a numerical split between those two functions and because they're intertwined you know it's important conceptually to make that distinction even though of course the same asset purchases are playing by rules. Maybe it's worth having a quick word on inflation because you've said that this is a big disinflationary shock from the pandemic. I was watching the local German TV last night they had a very nice report about how vegetable prices and fruit prices had gone up in in the supermarket because for example lemons grown in Spain you now see the the people picking the lemons have to be socially distanced they have to come on a big bus which costs more for the the farmer to provide and then the transport of the lorry driving from Spain to Germany cost more because on the way back to Spain it doesn't have anything to put into it so their message was oh look prices are going up but actually I think what we're saying is we expect on balance prices to go down. Right so I mean it's absolutely correct and it's visible I think in a lot of countries for example that kind of perishable food item is going up in price right now. So there's a certainly a degree of circumstantial inflation that if you are in a sector which has a very high demand so supermarkets are quite busy and at the same time as you say there are kind of new cost components because of the social distancing and other dimensions there will be particular types of prices that go up but in the overall scheme of the whole European economy many firms are facing a situation of much lower demand they used to face. So as the economy recovers as these firms try to drill up business try to convince households which are maybe quite nervous about spending then there's a lot of them going to be a lot of downward price pressure so I think you know the it's hard and by the way going back even to the Great Depression we know when we've had these really large slumps before the dominant initial dynamic is going to be disciplinary. I agree there's an open question about the meeting term about maybe whether there's also some forces in the opposite direction but by the way some of the forces in the opposite direction will be the outcome of failure. So for example if there's a failure to maintain the productive capacity of the economy if too many firms go out of business and they don't come back if too many workers become unemployed and get trapped in a kind of long-term unemployment problem then the productive capacity of an economy will decline in the medium term and that on its own is a force that would not be good for the inflation outlook. So I think I wouldn't find any reassurance in scenarios where people will say well because of the you know decline in economic potential inflation is going to be more likely. So you know but I think that for now for the horizon of margin policy of making sure the next number of months are we do what we can I think the pressure is mostly disciplinary. Okay so looking at the the other thing that we're doing these targeted longer-term refinancing operations or teltrose that's about liquidity which Jordy spoke about but maybe we can go a bit further on that one. The idea there is basically to ensure that banks are still in a position that they can lend to firms and households. Right so in a big downturn the temptation for banks is to pull back. Oftentimes we are seeing that even though firms and households are looking to borrow to smooth out the impact of the downturn on their expenditure banks are looking at a downturn and saying well maybe it's too risky to make lending decisions. So what the targeted lending program does is it provides very generous funding to banks but conditional on maintaining lending. So it it basically offsets the kind of temptation to have a credit squeeze in a recession by providing the incentive to maintain lending and you know I think this is now the third generation of targeted lending programs at the ECB. We've learned a lot we understand that that these can work quite quite effectively and all the indications are is that this new targeted program will be quite effective in the coming weeks and months in ensuring that the downturn that we face is not made worse by by a credit squeeze. You've mentioned several times already the the the Great Depression and some of the historical comparisons that are being drawn. So maybe we'll let's finish with a perhaps unfairly impossible question but you can give us some indication of where your thinking is which is the long-term effects of this crisis on our economy and what what are your sort of initial thoughts on that where where does this lead to? Of course I mean you know I'm sure we're all reading the same stories. For individual sectors it's possible to to imagine that long-term effects and the future of the office and the future of travel and so on but from a lot of that it's going to be a reallocation if you like. Some sectors will see increased demand other sectors may see reduced demand. So for the ECB our major focus is on the overall macro effect and there I think it remains the case that unlike the Great Depression this should not last a very long time. This should be a significant recovery and if you like the major damage to the long-term it would be if you like if there were policy failures that made the the crisis worse than otherwise and led to longer-term inactivity where the level of demand in the economy doesn't recover sufficiently to to allow full employment to return. So I think fiscal policy makers and multi-policy makers have a heavy responsibility and outside of those policy areas of course the major factor is going to be the public health challenge of getting this virus under control. Okay Philip thank you very much and thank you so much for joining us on the line over from Dublin. I hope the internet played along okay with both of us there. Okay thank you Michael thank you. Thank you Philip. This brings us to the end of this episode we've seen that in the current extreme situation brought about by the coronavirus pandemic the ECB is determined to support people firms and banks through the current crisis. Stay tuned for our next episode which will discuss how the coronavirus crisis has impacted financial markets and what our role is there as a central bank. As usual we're linked to a few publications by the ECB in the show notes as well as other related information including our web pages that aim to explain the ECB's measures in plain language. We'd love to hear your feedback and thoughts for future episodes via social media. You can use direct messages and comments. You've been listening to the European Central Bank podcast with Michael Steen. If you like what you've heard please subscribe and leave us a review. Until next time thanks for listening.