Interview: The European Central Bank president says the bank must anchor inflation and achieve market transparency in response to the oil shock, writes Marc Coleman, Economics Editor
Dr Trichet, the euro zone is facing its third oil shock and its first as a single currency. What can the ECB do to help?
It is true we have an oil shock, which is very significant, but it is different from previous shocks. This one is not primarily driven by supply restraints but by buoyant world demand that is changing relative prices for a number of other commodities as well. So we have to be careful in analysing the effect of this shock.
It is the job of the ECB's governing council to be as credible as possible and therefore to solidly anchor inflationary expectations.
It would be very damaging to the European and the world economy if oil price spikes would become enshrined in inflationary expectations and thus lead to higher permanent inflation.
We are therefore being particularly vigilant in order to avoid such destabilising second-round effects that might damage growth and job creation. We have said clearly to markets, observers and the people of Europe why avoiding second-round effects is important for the European economy. Until now this is well understood by observers and social partners.
When the G7 group meets this weekend, how should it respond to the oil challenge?
The G7 needs to discuss what has happened with oil and how to deal with it collectively. Oil remains a major risk, just like global imbalances.
There is a strong consensus amongst central banks on the necessity to strongly anchor medium- and long-term inflationary expectations. The credibility of the central bank in being able to deliver that anchoring is key.
Let me say as well that I am convinced that we must make progress in achieving transparency in oil markets. They do not function well and they are too obscure in all constituencies: producers and consumers.
You mentioned global imbalances. Do you think the G7 should put more pressure on China to revalue its currency?
Everyone has their homework to do, as the G7 has already agreed. Europe, as well as Japan, has to embark on structural reforms that would elevate the level of growth potential, to have more growth and job creation.
The contribution of the US is the reduction of fiscal imbalances and the elevation of the level of overall savings in the US economy. We had a consensus on that. The G7 also had a message not only for China but for emerging Asian economies to the effect that a smooth and orderly appreciation of their currencies is certainly part of a more balanced global economy.
Absolutely none of these contributions must be ignored. Small streams make big rivers.
Silvio Berlusconi said last week that the Italian government will not do anything in the case of the governor of Banca d'Italia, Antonio Fazio, and that it is up to the ECB to take action.
What are your plans to ensure that the code of conduct of the ECB is respected?
Our position is crystal clear: Firstly, we are inflexibly attached to the single market, to the level playing field and to not taking account of nationalities. That would not be in line with the treaty and with what is good for the economy of the euro zone and for the European Union as a whole.
Secondly, we are strongly backing the most intimate co-ordination between the various supervisory authorities.
Third, the governing council has asked Banca d'Italia to give us information; we have received it and asked for further information, which we are examining. Now we are in the process of close monitoring of the situation.
The latest ECB projections are based for the first time on an estimated potential growth of lower than 2 per cent, meaning that the output gap - the difference between potential and actual economic activity - is smaller than you thought before, with less slack than you thought.
Does this imply that you should raise rates?
You have to distinguish between the long-term trend of growth potential which is, according to most international institutions, probably close to 2 per cent but above 2 per cent, and the yearly growth potential.
But ECB executive board member Bini Smaghi has said in an interview that the new projections are based on a potential growth rate of below 2 per cent.
Precisely, the yearly growth potential for 2005 and 2006 is probably at the level of 1.9 per cent, according to several international institutions. We could be back at 2 per cent or above in 2007 and later. But in this respect productive investment and structural reforms are of the essence. This is why we are strongly calling for reforms.
What does that mean for your monetary policy?
We have to be totally pragmatic, to be humble in front of facts and figures. We are very cautious when monitoring the twin concepts of growth potential and output gap. Experience has demonstrated that they could be dramatically revised over time.
I trust that we must capture all information possible in our monetary policy decisions and not be prisoners of any single system of equations for our decisions to be as robust as possible. I am very much in agreement with Alan Greenspan on this point.
Some hopes for higher growth following the introduction of the euro have been disappointed. How do you explain this to the public?
We trust that thanks to the euro being set up and in comparison to what would have happened without the euro we are in a better situation in terms of growth, job creation; stability, internal dynamism and protection against external shocks.
But even better than without the euro, that remains not satisfactory and we know why it is not, because there is an overwhelming consensus of academic institutions that the call for structural reform - made not just by us but also by the commission, IMF, OECD and others - is not matched by delivery.
Those who have being doing these reforms have been magnificent performers. I quote Ireland. Has growth been disappointing in Ireland? I could quote other cases. We would all be better off if we engage in reform. The euro is helping, but it is not sufficient alone.
One political party in Northern Ireland - the Social Democratic and Labour party - proposes for Northern Ireland to be part of the euro zone. Have you any observations on the technical or legal feasibility of this?
I am not aware of this proposal but I hope that at some time the United Kingdom will enter into the euro zone. I have no doubt on that in the medium term. And I also am very confident that all the 25, and one day 27, will be members of the euro zone and not only the 23 that have no "opting out" clause.
Are there any areas of the euro zone where the real estate market calls for action by domestic policy makers?
Although not alarming at a euro-zone level, we have a lot of good reasons to follow up and monitor closely what happens in countries of the euro zone. In some countries of the euro zone - which are very dynamic and have a lot of real growth - there is a case for as appropriate national action as possible to calm down the market.
Monetary growth is growing faster, instead of slowing down as the ECB expected some months ago. How much longer can you live with that without raising rates?
This is an important question. The monetary pillar in our concept is important because we believe that in the long run inflation is a monetary phenomenon. The dynamism of the monetary aggregate M3, and its most liquid component M1, particularly sensitive to the low level of interest rates, is significant.
It is also telling to see the dynamism of loans to the private sector that is much faster than growth in GDP in value terms. This is one of the reasons why we are in a posture of particular vigilance.
With its clear monetary strategy dimension and quantitative definition of "price stability", the ECB differs from the US approach of "policy activism". What justifies this different approach?
Our transparent definition of price stability, meaning an inflation rate of under but close to 2 per cent, is important for communicating to observers, households and all economic agents. We help all decision makers if we are clear what our anchor is and if everybody knows that we will not hesitate to act if necessary to ensure stability. I would call that an "effective deterrent". I trust that our posture of credible vigilance has permitted us in the past to regain and preserve control of inflationary expectations without having to move. The paradox is that we did not need to move because everybody knew that we could have moved any time.
Five out of 12 countries in the euro zone currently breach the 3 per cent deficit limit of the stability pact. Recently, you have criticised a very generous interpretation of the new rules of the pact. Does that mean that the relaxation of fiscal discipline that you and others feared has already started?
As you know, in the past we judged that it was not appropriate to change the rules. A consensus of the governments devised new rules. We immediately called for rigorous implementation of this new law. In some recent cases, the interpretation of the new rules was very much stretched, and I maintain that.
The executive branches know, as well as we do, pretty well that the system of Europe's economic and monetary union relies on serious and professional peer analysis, peer recommendations, peer support and pressures and if necessary, sanctions. We remind the executive branches that it is absolutely necessary for the sake of the economic and monetary union not to be shy in expressing opinions and taking decisions.
Given the importance of Germany to Europe, what do you expect from the new German government?
We are running the currency for the sake of all of the inhabitants of the euro zone, of all sensitivities and opinions. We are ourselves bipartisan, multi-partisan by definition.
To all governments, whatever their sensitivities, our message is: Let's be as determined as possible for the necessary structural reforms that will foster more growth and job creation. On our side, we are doing what we can to maintain price stability to preserve a low level of inflation expectations and therefore a favourable financial environment.
What do you say to those who say that the rejection of the draft European constitution was a rejection of the euro?
No, not at all. The message which was sent is complex, coming from very different sensitivities. We have to be pragmatic, realistic, humble. We have a lot of things to do with the present treaties as they are: completion of the single market, the best possible functioning of the economic and monetary union, the best possible handling of the enlargement of the euro zone, etc.
Let us concentrate on these very important tasks, which are largely linked with the formidable historical success of the European Union after the collapse of the Soviet Empire.
The executive board, the governing council, all the staff of the ECB, the euro system as a whole are concentrating on these tasks. Jean Monnet said: "Nobody can say today what will be exactly tomorrow's European structure, because tomorrow's changes, which will be triggered by today's changes, are unpredictable."
It is still true and it is, to my eyes, the mark of history in the making.
