 Welcome to the ECB podcast, bringing you insights into the world of economics and central banking. My name is Michael Steen and in today's episode we're looking back at the economic response to the coronavirus crisis over the past nine months and ahead to 2021. I'm very happy to say we're joined today with the ECB's chief economist, Philip Lane. Philip, welcome back to the podcast. My pleasure, Michael. So when we last talked on the podcast in May, we were doing so remotely. I think you were in Dublin and I was at my home somewhere outside Frankfurt. It's six months later. We're actually back inside the main building of the ECB, obviously doing this with the right hygiene measures and social distancing and so on. Just that little example shows you that we've learned a little bit about how we live with this virus and that we've adapted our ways of living and working. But how's it been for you? How have you worked through these months? So I mean, I think both the ECB and my own personal experience very much mirrors what we've seen more generally. So in the spring and that period from mid-March really until the end of May, we were in a severe situation where we were all by and large working from home. I spent a lot of time in Dublin at that time. But with the miracle of modern technology, you can work remotely for a sustained period. And really since then, it's been much more of a halfway house between normality. And then right now, here we are in mid-December with maybe less in the office, more working from home. And that's been the experience with the ECB. It's been my experience. Lots of more time away from the head office here, but actually this autumn, quite a bit of time back in the office. And I think, as you indicated, that's partly we're learning to live with the virus. You managed in the spring as the chief economist and the member of the governing council to take some pretty big decisions. And doing all that whilst working with your team at the ECB, with everyone in their houses, I guess. And then the governing council also meeting in this remote format. Do you have any observations or particular things you want to share about how that was? Well, I think we will all spend time at some point looking back and trying to recall that period with some perspective. But I think multi-policy and maybe the policy word in general, unfortunately, this is not the first crisis. And so in many ways, the lessons from the previous major crisis, the global financial crisis and the European sovereign debt crisis did mean we had a lot of experience about how to respond to a crisis. But I think we can look back to that period and, of course, not everything was going to be perfect. But I think by and large, the number one job for a central bank in that severe acute phase of a crisis is to provide stability, to stabilise. And we did that. So those big decisions, the pandemic, emergency purchase program, the cheap funding for banks, the teltrose and a lot of other measures, also measures by our banking supervisors, those were sort of born of the crisis in the crisis. And if you look back at the year, how happy are you about how those have worked and what are your reflections? So I think there are three goals. One was to stabilise. And because there was a lot of market dislocation at that time, the immediate priority was to stabilise financial markets. The second, we know quite often there's a credit squeeze. When firms are in trouble, the natural temptation, of course, is for banks to become more cautious. So we knew we had to offset that instinct, that impulse towards tighter credit. And that's where the teltrose came in, the targeted lending program. And then the third is when you have this large shock. Now, of course, at the immediate lockdown, you have to accept. I mean, if there's a public health emergency, you have to accept economic activity is going to fall. But in order to support the recovery, to enable the recovery from those declines to be as rapid as possible, that's where general monetary policy support kicks in. And so we needed a monetary policy to be sufficiently accommodative in order for the economy to get through this pandemic period. And that remains the challenge. You mentioned already the previous crisis, like the sovereign debt crisis and the great financial crisis. A bit difference here was that it was also hand-in-hand with fiscal policy in some ways. Can you talk a bit about what was the fiscal element here that was so important? Well, I mean, if you go back to the very start financial crisis, so in 0809, there was fiscal support then as well. Later on, when you had the kind of difficulty of deciding how quickly to renormalize fiscal policy in 2010, 2011, 2012, as we know in Europe, that caused a lot of problems. But the initial crisis response was was directionally similar in 2008, 2009. There was an extra rule for fiscal policy because the pandemic hits sectors very differently. There are some sectors which benefit, so the kind of high-tech sectors, which are happiness work from home, shop from home, have benefited, but travel, tourism, entertainment, restaurants have been heavily hit. And monetary policy works for the whole economy. When we need to have policies that support workers and firms in individual sectors, then that's where fiscal policy needs to take a lead. And we've seen it. We've seen extraordinary fiscal policy this year, and we're going to continue to need extraordinary fiscal policy in the next year or two. We're now recording this sort of in the nearly mid-December. It's just after both another governing council meeting where big decisions were taken and actually also significant decisions were taken in Brussels, more on the fiscal support side. The most recent measures that the ECB took, what have we done and why did we see the need to do more, I guess? So I think the key word about this is to prolong. So what we've gotten right now is a second wave. Now we always kind of knew there would be a recurrence of the virus to some degree this winter, but it's turned out that actually as we know now here we are in mid-December and across Europe there are restrictions of varying severity, restricting, again, services, those sectors which rely on social interaction. So as we indicated now, we think we have a recession again in these last months of the year. And so what that has essentially meant is the pathway out of the pandemic. We remain very confident, and now the news of the vaccine, I think we have a clear vision of the exit from this pandemic. But to form the bridge from now when we're in recession, when there's many firms losing money again, many workers who are at risk, to form the bridge to the other side, which we think about as spring 2022 essentially, 15, 18 months from now, that's why essentially we've reorganized, we've recalibrated the PEP and the TELTROS to get us to that point. And I think that's what a central bank is for, is to provide stability, to provide that kind of pathway to allow the economy to get through this, to support the economic recovery, and as you say, hand-in-hand to make sure that fiscal policy can obtain the funding needed to provide the fiscal support we need. And in that context, I think it's very important that we did get this agreement at the European Council. The Next Generation EU Fund will essentially be a major driver of economic activity for the next five years. And it's important we understand that we have a vision that will help the economy as they not just get through the immediate crisis, but also has a clear momentum that will help us in the post-pandemic recovery period. Okay, and you mentioned already that it's a slightly difficult kind of situation because there's the positive news on the vaccine, but the recession, I mean, I think the ECB staff forecast that there's a 2% contraction in gross domestic products in the fourth quarter. But at the same time, you also said the economic impact is less than the first wave. So there's quite a lot of information there, a lot of things to consider. So let me emphasize is that normally when it's dated as a 2% recession in one quarter, that would be... That's a big number, right? That is a dramatically big number. But because we had a 15 percentage point decline in the first half of this year, of course, rather to that, it's a much smaller number, but it's still a pretty big dent in the economy. Now, again, we do think quarter three this year, July, August, September, showed that the economy can come back quite quickly. So we are quite confident that there will be a significant recovery in the economy and in the inflation process. But we have such a big decline. I mean, I think maybe the better number to think about is the European economy right now is about 7 percentage points smaller than it was a year ago. So this is a really big decline. We understand the reasons for it. We are confident as the virus becomes contained and especially as the vaccines get rolled out that there will be a good recovery, but it's going to take a while. The vaccine will not instantaneously create the new jobs, create the new demand. And so there's probably a mismatch. So the financial markets can respond immediately to the vaccine news, but we do think the economy will take those 18 months. If you like, we think 2019 GDP will be recovered towards the second half of 2022. So, you know, the story of next year is going to be a major program of activity to get the vaccines rolled out. And then in the meantime, of course, the ECB has nothing special to add in terms of public health advice, but in terms of making sure the financing conditions are there to make sure that there's no interruption to the recovery process. That's our job. So we're building this bridge and that it's keeping financing conditions favourable. And the way we do that, there's two big parts of it, aren't there? There's the pandemic emergency purchases and also the TLTROs. We've mentioned both, but maybe we should just touch on both briefly. But maybe I just thought that underneath those two programs, because remember, maybe it's always the case that the most important policy tool at the Central Bank has is the short-term interest rate, which we have kept at a low level minus 0.5, because that very low level essentially enables and is the platform both for the PEP and for the targeted lending program. And the other part of the efficient route is not so much to have further cuts in the policy rates right now, but to focus on having the support for the longer-term funding. So when we do these asset purchases where we're buying sovereign bonds, corporate bonds of different maturities, it provides support for long-term funding, not just short-term funding. And that's very important for those who need to borrow to get through this crisis. And then the targeted lending program provides an incentive relative to the policy rate. And it's very important for that because we know when firms are losing money. We know when the overall economic environment has some clouds in it. Resisting that, countering that through a targeted lending program, we think is quite effective. Now the targeted lending, that works by the ECB giving banks very, very cheap access to money to help them lend on. Some people don't like the sound of that. They sort of say, well, why are you giving the banks all this money? Can you explain the rationale? I would try not to use phrases you use because it's actually not the case we're transferring money to the banks. They borrow the money, they offer collateral. The banks still are taking the risk. They're taking the risk of lending to firms, small firms, lending to micro enterprises, lending to individual traders. And essentially in a recession, typically the natural instinct for a bank is say, look, there's more risk about it. We need to either lend less or raise our lending rate to allow for a bigger risk premium. And what targeted lending does is essentially fight against that because by providing access to cheaper funding, it means that maybe the lending rate can be stabilized rather than going up. And that's essentially how it's working. We look at our tools and it's very clear that one of the dangers to price stability is if this recession were made worth by a credit squeeze. That's when banks stop lending basically. Right, exactly. And you can understand the spiral you get there. Going back to this phrase we're using quite a bit these days about favorable financing conditions. It really should not be taken for granted. Recessions tend to take on their own dynamic where there's this real financial interaction which is poor economic prospects make banks pull back. And if banks pull back more firms are unable to invest or to keep on financing their work in capital which makes the recession deeper. You've already talked a bit about the vaccine and how we're not sure quite what that means but how important it is and obviously that's not our role but it's a key input into what the economic story of next year will be. But it means also you are actually having to look a lot of health stuff more than normal. I mean that in terms of the economic projections these forecasts we make you and the teams of economists working for you now delving into understanding this a lot more to try and figure out well what can we say about next year? Could you talk about that a little more? The first of May we get about three scenarios. A baseline and then a kind of a severe scenario what happens if this pandemic gets worse and a milder scenario what happens if this good news arrives earlier. And I think that framework has worked very well. Back in May the team I think made the correct assessment is over time we would learn to live with the virus. So the same amount of infections now in terms of the economic hit is less than in the spring because both the health systems have learned how to deal with cases and retail has learned how to offer alternative ways of shopping we've learned how to reorganize manufacturing factories construction sites to reconcile social distancing maintaining a production. So I think they've done a really good job of being quantitatively I think a reasonable approach. But let me come back to this basic point it remains uncertain and that's one of the key words in thinking about next year and this is why if you like in our policy announcement yesterday we emphasized our flexible approach and our commitment is essentially to maintain conditions at a favorable level in order to allow the European economy to you know get out of this situation this bridge towards the post-pandemic period and that I think is the appropriate way to deal with what we have which is next year you know we think there's going to be a lot of news we've already got of course now in the UK at the initial people receiving vaccines that's going to be the story here in the Euro area very quickly and so we're going to learn a lot next year about how quickly the logistics can work we're going to learn a lot over time about how much protection these vaccines provide we may well have to encounter some disappointing news but we think the history of any big project sometimes is a bump in the road and again I think the fundamental philosophy of any central bank is to be a stabilizing force to deal with the good news to deal with the bad news OK I mean just quickly so the bad news I mean you've talked already in a speech in November about how young people often are the ones who lose their jobs first there's also lots of questions on what is the lasting kind of economic damage is there so-called scarring I mean do you have any further thoughts on that I'm pretty sure there'll be more scarring the more we tolerate a deepening of this recession so we very much are focused from our monetary policy point of view in doing what we can and of course the lead role is with fiscal policy so whether that's accelerating imperatives that were needed anyway such as digitalization and investing for the carbon transition whether it's providing support for those firms which are perfectly viable but they're just taking a big revenue hit right now and also recognizing in some cases there will need to be retraining, reallocation towards those sectors which look like they're going to grow more quickly and away from those sectors and we have to have a longer term adjustment okay and you're hinting there that there's also some seeds of hope in that right because there's also positive things that can come out of this there's a little bit of serendipity because of course changes in how we live and how we work creates new opportunities and we see that everywhere that businesses are responding so it's partly that it's just the serendipity of how the world adapts partly it's conscious, it's conscious in the sense of right now when there's a lot of spare capacity it's very good timing for governments to step forward to accelerate public investment and through the various support schemes also support those firms which have a financial problem but in terms of their economic contribution can make a very good economic contribution post pandemic okay before we let you go so the final question you've talked a lot about how we're building this bridge we're trying to maintain favorable financing conditions and how busy that's going to be actually for next year do you have any other big issues on your agenda for 2021? well Michael I mean you may have noticed that we've also been quite busy but maybe in a quiet way with the monetary policy strategy review yes we are you know doing public events we're listening and I think that's been very interesting this autumn to listen to different groups but it's a huge internal project for the ECB for the National Central Banks for sure 2021 is going to be busy not just with whatever's happening in the world but we're also trying to bring this strategy review to a successful conclusion and in a sentence how do you define the strategy review what's the aim there? well the aim is really I mean as you know it's been essentially 18 years since the last one is to at one level to validate or to cross check are we on the right path it's always good to test yourself and look at benchmarks and so on but also we know the world has changed we know the world has changed in terms of digitalization, climate change demography we're in a world where we know there's a lot of forces pushing down interest rates real forces if you like how a central bank can operate or should operate in that world is super important we're learning a lot, we know a lot but in the end we have to draw conclusions and that's really going to be the big project for this year is to bring all of that together and formulate a strategy that will bring us into the coming years okay Philip it sounds like it's going to be a very busy 2021 so I want to wish you a relaxing Christmas with your family in Dublin and see you in January thank you Michael and thank you to you and all your colleagues also okay this brings us to the end of this episode we've seen how since the coronavirus crisis hit Europe there's been great progress to support the economy and pave the way for an economic recovery policymakers have acted decisively to mitigate the impact of the virus on the economy and support all European citizens but as we just heard from Philip uncertainty prevails the virus is going to keep everyone busy for some months to come even with the good news on the vaccination we'd love to hear your feedback and thoughts for future episodes via social media you've been listening to the ECB podcast with Michael Steen if you like what you've heard please do subscribe and leave us a review until next time, thanks for listening