Interview with Jutarnji List

Interview with Christine Lagarde, President of the European Central Bank, conducted by Marina Klepo on 19 December 2022

31 December 2022

Eight months after you became ECB President, the Croatian kuna and the Bulgarian lev were included in the European Exchange Rate Mechanism II. After the shortest period in the ERM II of all new EU Member States, Croatia is now also about to join the euro area. Was such an outcome a surprise for you?

I will focus on Croatia, which is becoming a new member of our family. I believe it has achieved exceptional success and that is big news. Being able to do all that – covering all the areas within a period of ten years between accession to the European Union and euro area entry – is an incredible success. Croatia has implemented reforms and the necessary restructuring and done everything to continue to have sound public finances. So it fully deserves to be admitted to the euro area on 1 January 2023, and it is wonderful to welcome the 20th member to the family when we are celebrating the 20th anniversary of euro banknotes and coins. This is big news and a reason for all of us to celebrate!

Over the past few years, people in Croatia have had a chance to hear a lot of arguments in favour of introducing the euro, but the most prominent ones – such as lower interest rates and more favourable borrowing terms – have become less convincing due to a change in circumstances. People worry that the euro will only spur inflation. To what extent have these new circumstances changed the narrative in terms of the costs and benefits of introducing the euro?

It is good to have the euro because it can operate as a shield. Once a euro area country, always a euro area country. All for one and one for all. We are together in this, all soon-to-be 20 euro area countries. I am old enough to remember when France became a member of the euro area and we exchanged the franc for the euro. We were also worried that abandoning our currency and adopting the common currency might have grave consequences in terms of higher prices and less independence. However, looking back on 23 years of the euro and 20 years of euro banknotes and coins, we can say that it has paid off – the euro has brought protection and strength. The initial concern that prices will be a little higher can be allayed. I am certain that the Croatian government has taken the necessary steps, such as ensuring prices are clearly displayed in both kuna and euro. In France, too, we were able to monitor the prices in both francs and euro for about half a year. It is a really good way of providing information because it is difficult, especially for elderly citizens, to switch to another currency all of a sudden. I believe that pocket calculators (or apps for the younger generation) displaying the price of a desired product in both currencies are useful in that process, as they were to us in France. I also trust that there are arrangements in place to punish those who abuse the system, who take advantage of the conversion to raise prices. There must be a combination of measures in place to facilitate the conversion while, at the same time, not allowing it to result in difficulties for citizens.

A deterioration in loan conditions seems inevitable?

Interest rates are increasing for everyone. At the moment, ECB policy rates must be higher to curb inflation and bring it down to our target of 2%. That process is essential because it would be even worse if we allowed inflation to become entrenched in the economy. So, we must do it now, but this is in no way connected to Croatia introducing the euro.

As interest rates increase, at least depositors should benefit?

We have a mandate to ensure price stability, and we have to fulfil it.

Even though Croatia is currently in a celebratory mood, it faces numerous challenges. While the ECB’s June Convergence Report said that Croatia fulfilled all the conditions for adopting the euro, one could also read warnings that its potential growth rate is low and that more should be done to ensure it catches up with the living standards of other Member States.

I would like to say two things. Croatia is already very well integrated in the euro area. If you look at the denomination of household or government debt, a high level of euroisation is evident. Second, Croatia is a very open economy. Looking at investment and tourism, the benefit of not having currency exchange operations is unequivocal. I have been to Dubrovnik, that wonderful Croatian city, and the fact that, in the future, people will not even have to think about the exchange rate or conversion fees will certainly foster tourism, which makes up a significant proportion of Croatian GDP (around 20%), as well as investment. Finally, people in Croatia have demonstrated that they are able to improve the country’s circumstances, that they can catch up with other countries, that they can take the steps necessary to become a member of the club. I see no reason for this to stop now. My only advice would be: do not stop or rest on your laurels, but continue to implement structural reforms. Being a member of the club means pressing on with reform efforts and catching up with others.

The past experience of some countries, like Greece with its debt crisis and even Slovenia with its banking crisis, indicates that members of the club easily overlook what is important to undertake on time.

Croatia is entering the euro area during a crisis period, but the country is weathering this crisis successfully. So it is a matter of going ahead with that process, using all the advantages brought by membership of the euro area.

Nevertheless, Croatia cannot be said to have been particularly successful in implementing structural reforms, despite having managed to fulfil all formal criteria for admission to the euro area and even the Schengen Area? For example, reforms of public administration, business climate, the healthcare system...

Membership of the club will surely encourage and help the authorities to implement the reforms. The country will benefit from it.

Accession to the euro area changes the definition of international currency reserves. A portion of reserves goes into the Eurosystem, but the largest portion remains within the competence of the Croatian central bank which believes that it needs to continue managing them. However, there are different positions on this in Croatia’s public sector, including using a portion of these reserves for other purposes such as repaying public debt. What do ECB procedures say on this, what practices were employed by other new members of the euro area?

This is a rather technical but important issue. When a country joins the euro area, its national central bank (NCB) needs to contribute both to the ECB’s capital and to its foreign reserves according to the capital key.

The ECB foreign reserves are managed in a decentralised way by the euro area NCBs. The related income is recorded in the ECB’s profit and loss account, and will also benefit Hrvatska narodna banka, in addition to the other NCBs, who are shareholders of the ECB. Furthermore, each central bank is credited by the ECB with a euro claim equivalent to its contribution, which is remunerated by the ECB. Foreign reserve assets beyond this will remain on Hrvatska narodna banka’s balance sheet.

How do you currently view the economic situation in the euro area to which Croatia is being admitted? An increasing number of indicators suggest that the energy crisis may be less difficult than was thought a few months ago, so the recession could be short-lived and mild?

According to the December Eurosystem staff projections, the recession we feared is likely to be short-lived and shallow. We revised down our GDP projections for 2023 from 0.9% previously, and we now expect 0.5% growth. However, 2024 and 2025 will see a recovery and a return to previous growth rates. All these projections are based on an assumption of no additional shocks or worsening of the difficulties we are facing. There is a big “if”, and in the past 12 months we have witnessed risks ultimately materialising. When it comes to inflation, projections for the entire horizon have been revised upward, which is also the reason for raising interest rates, as well as for anticipating further rate hikes. An important factor in this respect is that we must not allow inflationary expectations to become de-anchored or wages to have an inflationary effect. We know wages are increasing, probably at a faster pace than expected, but we must be wary that they do not start fuelling inflation.

Obviously, the three important words “whatever it takes” apply almost equally to inflation as they did to the euro?

We have to take the necessary measures to return to our target inflation rate of 2%.

There are doubts as to the extent to which monetary policy can do that, given that the main cause of inflation is not consumption but rising energy prices and disruptions to global value chains?

We have to show resilience in the face of persistent inflation and we must be careful in considering not only its symptoms but also its roots. What is causing inflation? It used to be predominantly supply-side driven. But now we need to be careful that the domestic causes that we are seeing, which are mainly related to fiscal measures and wage dynamics, do not lead to inflation becoming entrenched.

What is your position on views that a deeper recession will be essential for curbing inflation?

Our staff, that is the ECB in Frankfurt and 19 NCBs (soon to be 20 including Hrvatska narodna banka), do not forecast a deep recession. As I explained before, we forecast 0.5% GDP growth for next year and 1.9% and 1.8% for 2024 and 2025 respectively. These are the conclusions reached by economic experts based on comparisons and harmonisation of numerous data. Croatia will also take part in that process as of next year.

In a way, the Croatian central bank Governor Boris Vujčić is a declared “hawk”; he believes that inflation growth comes at a higher cost than a temporary GDP decline and advocates more aggressive interest rate hikes and earlier quantitative tightening. Can you briefly explain the process of Governing Council decision-making and how consensus is reached?

First of all, I would like to say that I am very cautious when it comes to stories about birds. I have had the opportunity to see hawks turn into doves, doves turning into hawks... These are just stories. What matters is that the circumstances, the difficulties we are facing and the type of inflation we are fighting are inevitably changing people’s perspectives. All members of the Governing Council have different experiences and educational backgrounds, they come from different schools of thought and bring those views with them.

How does the process work? There are discussions at both committee and Executive Board level in preparation for the monetary policy meeting. The ECB chief economist presents the proposal to the Governing Council. One key input is the staff projections by the ECB or in cooperation with euro area NCBs, which are prepared four times a year. Then, members of the Governing Council have a discussion on the proposal put forward by the chief economist. Following a lot of reflection and discussions among the members of the Governing Council we arrive at a decision, which becomes the monetary policy for the entire euro area. This is then presented by me and the Vice-President at a press conference. Afterwards the decisions are explained by members of the Governing Council in their own jurisdictions.

How do you see the process of euro area expansion looking ahead? Some countries are not overly interested in adopting the euro, even though surveys show the majority of non-Member States except the Czech Republic being in favour?

Over a 24-year period, between 1999 and 2023, the euro area will have grown from 11 to 20 members, which is a clear indication that the club is attractive. Second, of the 27 Member States, with the exception of Denmark which has negotiated an opt-out, only six EU Member States are not members of the club. If they need more time, that is fine. When they meet the criteria and wish to join, we will be happy to increase the number of euro area countries, which is the ultimate goal of the Treaty.

Do you believe there are economic or political reasons in the background?

It is difficult to say, but it is probably a combination of both.