Meeting

A Conversation with Ignazio Visco

Thursday, April 11, 2019
Ruben Sprich/Reuters
Speaker
Ignazio Visco

Governor, Bank of Italy

Presider
Greg Ip

Chief Economics Commentator, Wall Street Journal

Governor Visco discusses Italy’s economic reform, the state of the country’s public finances, and the economic governance of the European Union.

IP: Good morning, and thank you very much for coming to our event today.

So the world economy is in a delicate place right now. The International Monetary Fund told us this week that the world will grow much more slowly than it had anticipated just a few months ago, and by far the biggest downgrade has been to the economy of the eurozone.

At the same time we’re experiencing a lot of political pressures in the form of protectionism and populism. Italy, for example, has been progressing for a year now under a government composed of left- and right-wing populists.

And I’m thinking, boy, this would be a great time to hear from a central banker who knows both the eurozone and Italy. Where is that individual? Where is he? (Laughter.) Well, thank goodness today we are so fortunate to have Ignazio Visco, the governor of the Bank of Italy, here to talk to us about that and many other issues. So, Governor Visco, thank you very much for being with us.

Let me start with a big question. The eurozone’s economic outlook has deteriorated significantly just in the last six months. The IMF alone has reduced its forecast for growth this year by over half a percentage point. The European Central Bank has also—where you are a member of the Governing Council—has also lowered its forecast. What’s going on? What is it that ails the eurozone? Why is it so weak?

VISCO: Well, first of all, thank you for the invitation. Good morning. I’m glad to be here, and so on and so on. (Laughter.)

And the—well, there are temporary factors and there are more complicated issues that are behind the slowdown.

First of all, the slowdown is not limited to the eurozone. It you listen to Christine’s speech about the IMF projection, we have 70 percent of world GDP that comes from economies which are slowly slowing down.

Temporary factors in Europe are relevant. There certainly has been in the summer and still going on a crisis that was higher than expected in the automotive industry—automobiles in Germany, especially, which has propagated to other countries. Italy is very linked—interlinked with the German automobile industry, produces a lot of components besides its own, obviously, producer. And this has lasted longer and it is a very relevant piece of the reduction, actually, that we have observed in industrial production in the second half of the year.

The latest figures for industrial production are confused because—confusing because we have seen also some positive results, certainly recently in France but especially in Italy last few years are pretty good even in January. January and February are pretty good, and they somehow make us feel that the recession may really have been technical as it has been defined in the second half, that these two quarters of consecutive minus-.1 reduction in GDP.

But besides these temporary—which are not limited, obviously, to automobiles—but there have been also other factors. Usually you talk about weather problems, and so on, and so on. There are—there are some more difficult things that have to do with uncertainty at a level which is certainly linked to global trade, trade wars and so on, and political uncertainty certainly has mattered.

In the case of Italy, we had so external factors that have pushed down demand, but also some internal developments which are summarized by a single figure. That is the doubling of the differential between the interest that is paid on Italian government bonds and the interest that’s paid on German government bonds. This doubling is—basically started after the elections last year.

Two, I’ll say, possible factors for that. One, the fear in the market that the agenda of the new government, which is a complicated coalition of two parties which really have not much in common, I would say, in the sense that they have agreed on basic measures. So this is in common, certainly. But they somehow still have different views. One is mostly in the north. The other is mostly in the south. They have some, say, prefer to favor, say, people close to retirement; the other prefer to talk to those who are out of jobs and poor and so on. So in this sense, this was a government coalition, odd coalition, at least nobody had thought ex ante that this would—but then it has been successful in this year. They had—quarrel developed, but they have always found compromises.

On the other hand, the way markets have understood some of the issues that were being debated within some of these parties, they understood it as anti-euro. Basically, complaining for the negative effects that the participation in the monetary union and basically summarized by the euro, being the single currency, had on the economy, on society, and so on. And out of that the fear was that maybe after Brexit something else might take place. And these cost—cost in terms of interest rate differential.

The second is the kind of program that they agreed upon—they have differences on other issues, but they agreed upon most transfers. So transfers, pensions, transfers—so reform of the pension reform implying cutting the retirement age for those close to retirement, relatively close to retirement. It’s temporary, but not negligible in terms of the total amount of money involved, measure taken by this government.

And the other agreement was on this so-called citizen income, which is not really universal basic income but it is some transfers that are provided to those who are defined below the absolute poverty line, which is a complicated statistical concept, which basically is around on average eight hundred—close to eight hundred euros per month. For those who do not work, who do not have a job, who do not really perhaps look for a job if you want, but—and who are mostly in the south.

So these are the two things that are being this government. And fiscal effects of these not being the expenditures really considered to favor a return to a higher rate of growth, which was absolutely necessary, has been seen as a risk in terms of the return of debt-to-GDP ratio to, say, more favorable figures, if you want. So this also accounts for the other part of the increasing interest rates.

So increasing interest rates and external factors have had two effects, direct and the effect of uncertainty having limited investment, private investment. This is certainly the internal component for Italy mattering very much.

IP: OK. We seem to be getting some microphone feedback. I’m just wondering if anybody can suggest how we could—should we push these away, or?

Q: Move them closer to you, yeah.

IP: Oh. Well, we have these lav mics, so—that we’re supposed to be—should we shut one of them off?

(Off-mic consultations.)

IP: Working? OK.

I want to come back to Italy, but first let’s touch a few things on European monetary policy. So is the European Central Bank out of ammunition, basically? I mean, the—you’ve maintained negative rates for some time now, a very large balance sheet. There’s now discussion of these targeted—resuming targeted long-term refinancing operations. Are you—is it realistic that this is going to get growth back up or get inflation back to target? Or is the eurozone more or less condemned to, like, below-target inflation for the foreseeable future and an economy very close to recession?

VISCO: First of—well, no, close to recession, I’d say we are not close to recession.

IP: OK. All right.

VISCO: So let’s put this out of the thing.

We have fought deflation. There was a deflationary risk in about—since 2015, ’14, up to 2017. And I think this is where the unconventional, as they call them now, measures were really directed to, and I think it has been successful. So no deflation.

But the target that we have is something like 2 percent, as most of central banks in the world by now. There is some little things close from below, but you know, it’s something that can be for the purpose of this discussion really considered 2 (percent). And we are far from that because the implicit projections, the consensus forecast and so on, tell that for a while we will be close to 1.5 (percent) if everything goes fine. So we are trying, really, to meet our objective.

IP: But isn’t it possible that inflation expectations—with actual inflation having been as low as it has been, could inflation expectations become anchored at this level and make it impossible to return to 2 percent?

VISCO: Well, for the time being yes, it’s—everything is possible. But, obviously—obviously, for the time being, we are seeing a reduction in inflation expectations, both from swap rate, as you can somehow compute. Then in that case, obviously, there is always a question about the risk premium attached to that, but—the term premium that is in the—in the calculation. But somehow there has been a reduction. And also, the professional forecasters that we survey are somehow hinting that there might be some longer-term inflation expectations below 2 percent.

But for the time—but this is why, I mean, we are maintaining a very easy monetary stance. It is easy. It is not easier because it was already so easy that we are patient and in this sense we—(inaudible, technical difficulties)—our monetary policy may turn too restrictive. And the kind of measures that have been taken recently are on one side trying to tell the markets that in this way that is called forward guidance that we will keep this easy stance—that is, interest rates low, so low—for as long as necessary.

Now, the interesting thing is that we are somehow discussing negative rates. But differently than other countries, the negative rates only apply to a component of the banks’ deposits at the central bank, which is—which is at the end something that cannot go on forever. It’s very unconventional to have negative rates, nominal rates. But I don’t think that—the issue is really that we have low rates, and—very low rates, and these are the rates that are attached to the unconventionality in monetary policy. That is, we are now maintaining in our balance sheets a substantial amount of government debts and other corporate debt and so on, substantial for, again, at least some time, but perhaps we will see how long it will be necessary to keep them. And this is a stock effect.

Now, the interesting thing is that we are also trying to take into account the amount of liquidity that is needed in an economy which has some problems for banks, really, to get funds in the market. If there are difficulties, then we are ready to intervene with this new series of targeted refinancing operations. “Targeted” means that they will be linked to the credit that banks will be able to generate. So I think monetary stance is there.

Tools. Some say, well, you get out of tools. You never get out of tools. At the end, you can supply money in many different ways. If you raise your base money, then you have to understand whether inside money will be still there or not, so total money in the economy. But as we have concluded—and we often say even in the Governing Council—inflation is a monetary phenomenon at the end. And therefore, I mean, we stick to that.

IP: So let’s talk a little bit about the negative interest rate problem. As you know, there’s been a lot of concern that it interferes with the transmission mechanism by hurting intermediaries such as banks. Do you have any thoughts on how negative rates could be mitigated?

VISCO: We are discussing. Actually, we are still analyzing these effects. The figures are not very large, huh? The effects—these are side effects of a policy that is predicated in trying to convince banks or to help banks to refinance the government, so in this sense. And the—so it is an incentive for a bank, OK, that in the TLTRO we basically—if you have a negative interest rate, we will pay banks if they—if they will lend.

IP: Yes.

VISCO: At the same time, if they don’t lend, they don’t receive a return on their deposits. So this is—this is the component.

The question is, what side effects does it have? Well, it has side effects on the total profits of banks. And if you do all of the calculation, it’s not something large. As a matter of fact, it is—it is clearly—it’s easy to do the calculations. So you—but it has an effect, I think, of the unconventionality, because if you start having a negative interest rate there then the issue is whether it somehow provides a problem for banks in terms of their depositors. And then, for example, a complaint that you often listen in Germany is that bank depositors, those they don’t get enough interest rates. But they don’t get interest rates even from investing in government debt. Even in—and so it’s the state of the—somehow the monetary conditions that is pushing rates to be low.

So I’m more concerned about the appreciation that you have in the market of—and especially the investors and savers, about their feeling that they don’t get enough return, rather than from the negative interest rates apply to single banks. But we are going to study this because the issue that you posed is an issue of monetary policy, so whether this interferes or not. We don’t—we have views. We will try to make this clear in the next months.

IP: When do you think you’ll have an answer?

VISCO: Oh, but we are going to—by June we are going to have clearly defined also the precise parameters of this new TLTRO. And with that, clearly we will have a view.

IP: Sure. So one of the risks already over the world economy has been trade. There is an ongoing trade war between the United States and China, and there are frictions between the United States and the European Union over tariffs that the United States imposed on European steel and aluminum. And recently the United States announced its intention to levy tariffs on Europe as a consequence of subsides to Airbus. How much of a problem has that been for the European and Italian economies?

VISCO: Well, so far it is a problem of uncertainty. So, you know, this matters for investment. Investment—private investment is clearly predicated on having an idea of total demand. What will be—what will be total demand is really very much dependent on tariffs in this case because, you know, total demand coming from the rest of the world. And we have two very important manufacturing economies, which are Germany and Italy, and clearly they will be hit if there is—if there is a trade war.

My impression is that—I’ll give a personal impression here—is that the issue is more the move from multilateral to unilateral moves, and then—and then bilateral negotiations. So this is the issue.

So we have been for many, many years—I’d say decades—constructing a system of multilateralism. The objective was to reduce tariffs, to minimize tariffs, because trade—and this, I really think it exploded after the end of the Cold War. Trade was seen as a driver of growth, and it has been. It has been. And globalization has been an extremely important engine to reduce poverty at the world level. The only problem is that this—those who have paid for that is the middle class in advanced economies, and this is—this is, I think, the political—the political economy aspect of—that justifies these attempts at defending from global factors.

So I think it has an impact through investment first, and then—and then trade. We are still doing very well on the export side. If you talk about Italy, Italy has a surplus in its current account. It has a net foreign position which is balanced. The French is negative, 20 percent of GDP. Spain is 80 percent of GDP negative. Italy is in balance for a foreign position. It has a current account of about 2, 2.5 percent. So the risk is that this is felt.

IP: Does it feel that since it’s—the biggest trade dispute is, of course, between the United States and China. Europe is actually kind of a witness to that, but is not a participant in that. And yet, it seems that it’s Europe that catches the flu when this, like, you know, virus of protectionism erupts between those countries. Is Europe really an innocent bystander?

VISCO: Well, it is—first of all, we have to talk about global imbalances here and how you define global imbalances, whether the global imbalances are bilateral or the summation of a number of bilateral positions. How important are global value chains? Because perhaps—besides the trade surpluses and—or balances, there are activation of value-added, which is different country by country. So it is a bystander.

We started with China, who had clearly a major surplus for many, many years after its accession to the WTO. And this was the issue that we debated in the G-20 at least I would say since the G-20 became somehow a relevant body—policy body at the world level, so 2008-2009. The Chinese have substantially reduced it. And you really see that on one side there is more imports, which is not only imports of goods; also imports of services. Think of people traveling abroad is a service. Tourism is a service.

IP: Sure, yeah. Yeah.

VISCO: And this has increased very much.

At the same time, we had Europe having a high surplus, especially in Germany. And this is an issue that, clearly, is behind also the discussion between the administration—U.S./American administration and Europe at large. Think of the trade in Europe is a single policy. It is a union policy. But at the end, what is relevant is the position of individual countries.

So we have introduced in Europe something called macroeconomic imbalances procedures, which basically say that if you have a deficit in your current account of a particular percent then you have to adjust, and if you have a surplus then—and it is an asymmetry there. We have been discussing this at length, but the asymmetry is that the surplus also has to be adjust, but it may be higher than the deficit in absolute terms, so say 4 percent and 6 percent. Now, Germany has been above that. So this is—

IP: So what we really need is the Germans to adjust their surplus, yeah.

VISCO: This is an issue that we also discuss in Europe among European countries. There are two answers to that.

The first is you don’t want us to cut exports. We are competitive, and so—and so the answer is easy: no, start pushing up domestic demand and import more.

The second is more subtle. It has to do with demographics. And Germany’s aging. Italy’s also aging. Japan is aging. The aging countries have a tendency to accumulate somehow surpluses in order to have wealth sufficient to be used when it will be necessary.

IP: Let’s get back to Italy. We have a few more minutes before we go to questions. So Italy’s problems are not new. In fact, it is one of the few countries whose per capita GDP has not risen in the last seventeen or eighteen years. Why is that? And will the policies of the new government change that?

VISCO: First of all, this is a structural issue. Italy has had the rate of growth on average 1 percent less per year with respect to the rest of Europe for twenty years or so, even a little bit more perhaps. Plus, Italy has had the most severe economic crisis in its history since 1861 from 2011 to—let’s say even 2009 to 2014, a double-dip recession. Still hast not recovered from that. The GDP is still 5 percent short of what it was in 2007. What is behind? Well, simple story: productivity growth.

What is behind the very dismal, somehow, outcome of productivity in a country which had exceptional productivity growth in the ’50s, ’60s, even ’70s and ’80s? My view is that this has to do with a number of issues, but the main issue is the delay in the adjustment to the two or three major changes that has taken—have taken place after the end of the Cold War.

Globalization, opening of the world economy. The Italian industry—firms were too small; traditional sectors, family-owned and family-managed; and they did not adjust. They adjust their labor cost. They did not invest.

And they had to invest in new technologies, and this is the second major change. So there was not, I would say, enough ability to incorporate the change even in these small companies because there was no human capital.

IP: Sorry, I just want to make sure we cover all the contemporary points, yes.

VISCO: So, no, but then what is happening now—

IP: Yeah. Yeah.

VISCO: —then there’s been since the sovereign debt crisis a large number of initiatives trying to do structural reform, and some of them have been successful. So we had substantial effects in the startups, innovative startups, through incentives and so on. There has been labor market reforms. There have been also in the private sector investment in new technology. And what is happening now is that since last year I think the focus has been—and we started from that—most on transfers and not on growth. So this is the basic problem.

And—

IP: And do you think those transfers could have the effect of doing the reverse, of unwinding some of the benefits of the—

VISCO: No. The transfers will have an effect on aggregate demand, but they are not going to change productivity as, for example, monetary policy. Monetary policy is not going to have any impact on productivity growth. You need structural change. In other words, structural change, you need to somehow do two things, the private sector and the public sector: to invest in innovation and technology and to invest in human capital. And this is the second component which is really missing in the last twenty years.

IP: OK. We’ll go to questions in just a minute, so please raise your placard. And I’m going to ask one last question before we do that, but if you’ll put up your placard I’ll know to ask.

The last question I want to turn to is the independence of central banks. So here in the United States there’s been a lot of questions or concerns raised about the president’s criticism of the Federal Reserve and his intention to nominate two individuals who are known mostly as partisan advocates rather than technocrats to the Fed. And in Italy you’ve experienced some of this yourself; there’s been a lot of criticism of the Bank of Italy by the populist government. And this has taken the form of some initiatives, for example a proposal to essentially take the gold that is owned by the Bank of Italy and give it to the people. Where does this criticism of central banks come from? And how concerned are you about it affecting your ability to do—the bank’s ability to do its job?

VISCO: Well, our ability to do our job is not affected. We do monetary policy, and we do it in a basically collegial way in Frankfurt in the ECB. And so total independence, and that is not questioned. Obviously, also, the ECB is under attack and under certain—from certain quarters.

We do supervision. And this is a real issue. There have been bank failures in Italy, some small banks. It has been grossly overemphasized, I would say, but—and it has been severe for those who have been hit. But we—this is less than 10 percent of the total banking system, much less. And it has—in a country which has had a fall of GDP—(checks cellphone)—oh, sorry, it is mine; you don’t hear; OK. In a country which has had 10 percent, almost, falling GDP, 30 percent falling investment, doubling of unemployment, we had, obviously, an increase in NPLs and so on, but—and we had bank failures. I think bank failures were the result of the difficulty in managing bank crisis more than in supervision. It’s very difficult to somehow discuss this, explain this, and so on. And the bank has become the scapegoat.

For example, the bank has nothing to do in the sales from banks to the customers of bonds or equity and so on. This is not in the realm of the regulation that belong—that is attached to the bank. Bank surveys and is part of the crisis management, which is however now a European issue. And so I’m pretty critical of the way we have put together this system of—this approach to crisis management, but we may discuss it later.

I think mostly is a reaction of the dismal economic conditions outcomes, which has to do with the view that this is linked to finance, to banks, to technocrats, to the establishment, and to the elite. And in Italy, the elite, the establishment, the technocrats, those who know are in the Bank of Italy. So it is—it is well known that somehow the major, say, attempt that you may have to get popularity is to—but we do our job.

I don’t think—on gold, gold is a different thing. Italy has—the Bank of Italy has about one thousand billion—one trillion assets; ninety billion is gold. It has been purchased over the years through—with monetary base, basically, so it’s part of our reserves. We have that. We have foreign currency. And we have about three hundred and fifty billion in bonds, government bonds and through the QE, and about two hundred and fifty in refinancing banks. So total these together, that—so it’s 10—less than 10 percent of total assets, but it is a symbol.

And so the issue is, who belongs—who does this gold belong to? And so these parts, ah, no, these parts, no, the whole thing, some of these people say, well, it belongs to the people. And of course it belongs to the people, because the Bank of Italy is a public institution. But the Bank of Italy is a public institution, but through history it has shareholders which were banks. Then there has been—and banks at the time were public banks, owned by the state. Now they are mostly—or accept a small one—all private, so the shareholders have become private. At the same time, there has been a law that has reduced the shareholders’ possibility to enter into the capital of the bank because you can only have at maximum 3 percent of the capital. And you not only have to—you can be a foundation, public foundation, an insurance company; you can be the, say, order—I mean, the group of professionals, be physicians and so on; so it is very wide now. But still, it’s private, so it’s not—

IP: Yes.

VISCO: Now, it’s seven—you have 7.5 billion. This is the capital of the bank. What is the net worth of the Bank of Italy that belongs to people? It’s 130 billion.

IP: So we’re not talking about a significant share of the bank being in the hands of private banks?

VISCO: So—yes, it is not that.

IP: OK. All right. But as you say, the symbolism is very powerful, yeah. Yeah.

VISCO: The symbol is very important. And in the conversation that you have in social media and so on, this is an issue. So we are trying to communicate better, to explain better. It’s very hard, but we will continue to do so. At least I don’t feel affected in terms of—(inaudible, technical difficulties). Obviously, we have to be accountable. We need to—(inaudible, technical difficulties). And we run the payments system in Italy and in Europe, which is something that nobody really knows. So it’s monetary policy, supervision, and payment, technologically extremely advanced. So this is—this is one of the things that makes the central bank—our central bank very important also.

IP: OK, thanks.

So we’ll go to some questions now. As usual, please keep your questions relatively concise and do make sure they are questions, not simply comments. So we’ll start with you.

Q: Thank you.

As you know, Italy—Italian—Italy invented foreign exchange targeting. It was done under Mussolini, where he said that the lira should be ninety to the pound sterling. It was a period of discipline, therefore, in the issue of currency. This was a period of—before 1945 when Italy experienced mass bankruptcy, breakdown of the economy that created—(inaudible, technical difficulties). That’s how the Italian state—(inaudible, technical difficulties)—the system.

The second period of monetary discipline is since Italy’s entry in Europe. Now, people used it to explain populism, but if someone were to look at the Italian growth numbers and the debt—the chairman mentioned it—the growth in Italy ends when monetary discipline begins. The last time monetary discipline was imposed on Italy—

IP: I’m sorry, is there a question?

Q: —growth also ended.

IP: We need a question.

Q: And so the question is, since the Bank of Italy commissions all sorts of studies, and with admirable transparency you put them on your website, have you ever done a study of the costs and benefits of the euro?

VISCO: Yeah, I mean, there is no—I think it has—

Q: And cost to benefits.

VISCO: Yeah, yeah, no, no, no. I mean, obviously, the monetary discipline was there also before. Even before the euro there was monetary discipline. In the 1990s we have been absolutely instrumental to entering the monetary union through discipline, but it has been disciplined even when the walls—the so-called—before the divorce between the treasury and the Bank of Italy, when Italy was—when the Bank of Italy was obliged to purchase the bonds which were not—which did not have demand in the market. Actually, it was a minimal effect. I don’t think that there’s an issue of monetary discipline.

The euro. Well, the euro has not had any effect on the economy in terms of exports, for example. Italy has still not only a surplus, but a very efficient, if you want, export-oriented manufacturing, even services. No, I don’t think—I think it’s a symbol.

I think this is—the Mussolini thing is a different thing. This was the—1936 was the end of a number of bankruptcies that was linked to the Great Depression, is the Great Depression in Italy had that kind of form. But I don’t think that what we are observing now has to do with monetary effects. It has to do, I think, with the long period of relatively modest political advances to face a new world and extremely difficult reaction on the part of the private sector to the changes I was mentioning, coupled with aging, which was a demographic change which was underestimated in its impact.

IP: Thank you.

Doug?

Q: Thank you, Mr. Governor.

You ended your remarks by starting to get into the banking supervisory role of the Bank of Italy, so I just wanted to pick up on asking your thoughts on the status of two sort of pending banking-related issues in Europe.

One, what is your sense of the so-called bank sovereign doom loop, with Italian banks are particularly acutely focused on, or at least the Germans are focused on the Italian banks, of the large holdings of Italian banks of Italian sovereign bonds?

And second of all, on banking union more generally and the resolution issues under BRRD, where Italy has been a creative implementer of existing rules, whether you see in a new Commission a new rethink of the BRRD and those related issues, and how those would relate to your role as a supervisor of Italian banks.

VISCO: Thank you very much.

The doom loop or this bank sovereign circle is something that we discuss very often. As you may know, there are initiatives also in Europe that try to somehow suggest that risks should be attached to government bonds in different ways—something that the Basel Committee has studied at length, at the end concluded that it was not the proper way. My feeling is that there is an issue of the sovereign, but it is the sovereign is not only not match the banks owning government debt.

Assume that banks did not have government debt; somebody else should have government debt. So you should have a general equilibrium approach to try to see what would be the effect. Assume that there is a country which has a lot of government debt in banks and this country defaults—not talking about Italy; it’s an experiment. What do you think the—if the banks did not have government debt, they will be affected or not? They would be equally affected. So it is an issue, really, of putting under control the government debt.

At the same time, obviously, if a bank develops—puts much of its—of its assets in bonds rather than in credit, we are worried because we want—we think a bank mostly organized to provide credit to the economy. So in this sense, then you have to ask why are they making choices of this.

So we had two moments which I focus on. The first, 2011/12, sovereign debt crisis I think generated by a bad sequence of events. I’m not going to elaborate on that. But at the end it hits countries which are somehow like Italy and Spain, after having hit countries which have the clear idiosyncratic problems. Italy is affected, first of all, from the lack of funding in the interbank market. There is funds which are somehow frozen from money market funds, from sovereign funds in Asia and so on, and this creates a crunch. The crunch produces problems in the private sector. There is—demand for credit goes down. We intervene with long-term refinancing operations. The banks get back the funds. They don’t have any more the customers. They accumulate debt, public debt, wisely, because at the end on one side they played the contrarian investor job and secondly because they got a lot of capital gains when the monetary policy made it clear that the redenomination risk, which was the major risk of breakup of the monetary union, was basically nonexistent.

Now we have a different thing. After these last elections we have seen again an increase in interest rates, much less than increasing the spread that we observed in 2011 but still visible. And this means that government debt has returned which is higher than credit. If you look at—and this explains why we have a pickup in the debt that is in the—in the bank’s portfolio. But while this is not an issue for the what we call significant banks, the largest banks—say 60 percent of the market—it is significant for smaller banks.

Now, we are investigating it, of course. But one simple answer, elementary answer, is that a small bank has—which sees that there is a risk in the economy coming from public finances, why does it go into the debt rather than do in credit to the small firms that operate with it? Probably because the risk is for both, and the one that pays a higher return is the one that they favor.

So we—I’m concerned that there is a lack of credit. And this is why I think—but it has two things: demand and risk. This why I push very much in all my intervention discussions with the government and so on in having the debt under control, public debt, even if we have to look with care what happens in the banks’ portfolios.

IP: Did you want to answer the question with supervision and how much—

VISCO: Yes. This is an interesting issue because we did—there was a crisis, sovereign debt crisis. Europe was somehow not making any progress on monetary union and decided to make progress, pushed for example among others by our prime minister, which was Monti at the time, in the baking sector, having a banking union, following up the steps that we have had on the monetary union. It took about ten years to generate a monetary union. It took one year to put the banking union in operation. Great success. I think we have been extremely successful on the supervision side, even if we may have been discussing having different views. But clearly, the establishment of the single supervisory mechanism has been a success.

Not so, I would say, the resolution—the crisis resolution, bank resolution side, and not at all the deposit insurance leg. So this is a problem.

On the crisis resolution, I’ve been critical from the very beginning not because I am against the bailing or other things like this, but because I think the implementation of that was not well-thought. And at the end we have been hitting—I mean, trying to solve small banks crisis in the same way we pretend to solve or not to solve the too-big-to-fail banks; that is, asking for a number of intervention on the liability side, having rules for liquidate the bank or resolve the bank which are equal across the board, even if small banks pay for the resolution fund but cannot get resolved—they have to be liquidated. And so I thought that a good use—a better use of deposit insurance mechanism would be—like FDIC, for example, in this country—would have been a wiser—a wiser way for small banks. Think that we had—the crisis that created all these problems was a crisis confined to four small banks which had total about 20 billion euros, I think—I mean, less than 1 percent, less than 30 billion euros assets—which means that none of them was not only significant, but all of them were not significant. And think that the FDIC has—provides the solution of bank crisis for banks which are four times these average. So this is what we are missing.

Now, the problem is that in this case this is an insurance system that is public, federal, and which has resources that are used to intervene in the sale of assets and liabilities or aggregation of banks, small banks, with others. So this is what we have done in the past before the decisions that was taken in 2013 to go on with this new system, and we success. We have closed one hundred banks. Nobody has noticed it. But they have been closed, the assets have been sold, aggregated to others, and so on. And then now we have not been able to have this insurance system, deposit insurance system, which is private but is run in a way by the private sector to avoid contagion and to avoid financial instability.

We had the problems that this could not be used. A recent judgment by the European Court of Justice has just said that the approach that was taken was wrong, but unfortunately this came after the fact and not when we were asking for it to be better operationally.

Now, I think that we have to proceed in a European direction. The FDIC, I think that this is well understood in Brussels by now, and I’m confident that this is something that will be at least for the future helping us a little bit more.

IP: Larry?

Q: Ignazio, I’d like you to respond to perhaps my provocative view that there is a crisis in central banking, and the ECB is an example of it, where central banks are no longer able to meet their inflation objectives. And that reflects the fact that the Phillips curve is so flat. And when inflation gets to 1 percent core in the euro area, inflation expectations become painfully adaptive on top of it. So I don’t see that there’s any degree of easing that the ECB could promote that would get inflation back to close to 2 percent in any meaningful medium-term period.

VISCO: OK. Larry Meyer is a Modigliani student, so—(laughter)—it is clear that you don’t think that inflation is a monetary phenomenon because this is a Friedman proposition.

Q: No, that’s not what I’m saying.

VISCO: But—

Q: It’s not that it’s a—it’s a central bank issue, not a monetary. It’s a central bank issue.

VISCO: But the point is that you have to admit that we have ways to generate money. And think about helicopter money, right? There are possibilities. I’m not say—I don’t—we can study what does it mean and so on, but what we have been doing is purchasing paper and creating money. If the inside money is going down, then you have to replace that. And you may have to have easy conditions for as long as necessary. You have to be patient on that.

But I think at the end the risk is another risk. The risk is that you have to take under control the prices of not goods and services, but those assets that may be the object of this creation of liquidity sooner or later. So in this sense you have to—this is why we have these tools of macroprudential and so on, which are somehow very relevant for particular asset classes, say real estate, uncertain for other asset classes which are more volatile and perhaps not well-studied yet. But I’m confident—and I don’t think that I could have a different answer.

It is obvious that it is a long period of inflation being below 2 percent. And the medium-term aspect of that is not that on average we have to have 2 percent. But when the economy is somehow in a state in which it is growing at a decent rate and so on, you have associate to that a rate of inflation of 2 percent. Difficult? Yes, difficult. The case of Japan is clear. Is not—is not an easy—an easy job, but is the only job that we are—we have to do. I don’t think that there is anything else. And if you have a different recipe then it would be interesting to discuss.

IP: Thank you.

Daniel?

Q: Yes. A few weeks ago the Italian government signed a memorandum of understanding with China to become participants in the Belt and Road Initiative. One of the concerns that has been expressed is that there hasn’t been a great deal of transparency in the nature of the loans that are being given to the participant countries and there can be debt entrapment. And this created a degree of alarm on the part of EU members, particularly France and Germany. I’m curious what tensions might be brought to bear on the Bank of Italy as being part of the ECB and being caught in between. Have you seen or foreseen anything along these lines?

VISCO: No. First of all, neither the Bank of Italy nor the ECB have been involved in this.

Q: I was just—more abstractly, I’m just curious if you have any projections.

VISCO: No, no, no. Not at all.

Q: No.

VISCO: I mean, this is—this is—this is really—I don’t know whether it’s foreign policy or economic policy, to be sure. On the other hand, there is a recognition that one has to have. We have a big player here, and China is a big player. The question is more a question whether this is something that Italy should have done as part of the European Union or as the only G-7 who has been in this. This is—this is, I would—I would say, the real issue.

Europe is a union, and therefore is not a federal state which is—which is—so there is this difficulty of acting together in this sphere. But I think at the end the recognition that the—China is a player we cannot ignore is relevant, and we cannot ignore as Europeans. Marty Feldstein twenty years ago wrote a piece saying, well, you do the monetary union and you risk really generating turmoil, if not war, it’s going not to be a good thing, and so on. I was the chief economist at the ECB at the time, and I had a long discussion with him. My point was: It’s better to have a chair with two legs or a chair with three legs? So the problem is we should be involved—heavily involved in constructing the third leg rather—and in this sense I think the Italian government has to understand that it has to come through dialogue with the others, but I think they understand it very well. I don’t think that it is not well understood.

And the other thing that you have to consider is that this is certainly an initiative of this government, but it started with the previous one. And the previous one was not, if you want, the kind of government that was generated out of criticism of the technocrats and so on and so on.

So it’s—then the what will be this Silk Road, what will be these initiatives and so on, is something that is in the making because, obviously, we come from times in which the Western world was criticized because they were colonizing the rest of the world. There was—we remember—I don’t know whether you remember; I certainly—I remember the Third World. And so there was a Third World, and now China is expanding, trying to be relevant in Africa, relevant in Latin America. Now, in this sense I think we have to—I mean, something that is outside the realm of central banks, but as citizens of the world we have to understand what is the best way, really, to guarantee a stable world system, and whether the initiatives that we are engaged in at bilateral level are really to be somehow put into a multilateral framework rather than maintained on this bilateral level.

IP: Could I ask a related question? So the United States has actually, you know, criticized participation in Belt and Road, and they believe that it’s a national security issue. You know, Italy is a member of NATO. It’s a transparency issue. Is the fact that the United States opposes participation in Belt and Road, should Italy take that into consideration? Is the view of the United States less potent given the tensions the United States itself has initiated on transatlantic relations?

VISCO: It is a question I put to myself. I’m not the government, so this is a question that you should put to the Italian government. I don’t know what to answer as a central—I’m more the central bank.

Obviously, I think the issues of security, we are very much engaged in that. Cybersecurity is one of the things that we are very much working on in the country and European level in the G-7. So this is—this is something that is part of what you are saying.

But, you know, security goes both ways. It’s not only—it’s not only from China to the United States.

IP: OK. We are at 11:00 now, so I think I’m going to wrap it up now. I’m sorry I didn’t get to all your questions. Governor, thank you for all of your very thoughtful answers to our questions.

VISCO: There was—there was Eric next.

IP: Well, I—should I take one more? Oh, OK, Eric. Sorry about that.

Q: Yeah, sorry. Maybe back to inflation and monetary policy, just to kind of build on Larry Meyer’s question. The ECB’s target of 2 (percent) but slightly below 2 (percent), this—do you have comments on that?

And also, the Fed is talking about average inflation targeting, nominal GDP. Are there other, you know, areas the ECB could expand in from an expectations perspective to move inflation up?

VISCO: Now, when we talk about, obviously, first of all, this 2 percent is—can be defined. It is 2 percent in the medium term. So it is something that already is objective to an assessment of what the medium term is, and we may have different views among governors. It is the computation of how to reach that, whether you use energy, food, and so on or you take them out, or how important are these. But inflation expectation is the crucial issue. I really think that we focus very much on that.

And we—the de-anchoring—the risk of de-anchoring, we have a number of studies. There is a study by some of my staff, a very sophisticated study, that tries to see the link between short-term and long-term expectations just to understand where the de-anchoring risk is increasing. We are still in very, very modest figures on that as we are clearly very much far away from pricing deflation in our outlook. But these are issues that we follow exactly starting from expectations. Thank you.

IP: Thank you very much, Governor. (Applause.)

(END)

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