Ardo Hansson: the temperature is already too hot

Governor of Eesti Pank and member of the Governing Council of the European Central Bank Ardo Hansson says there is no reason to hope that interest rates on loans will forever remain as low as they are now.


  • Ardo HanssonThe central banker believes that the Estonian economy is already simmering on a flame that is too hot

  • Investment by the state may crowd out investment from the private sector

  • There is no way for borrowers to escape rising interest rates

  • Internet-based funding poses new threats

Governor of Eesti Pank Ardo Hansson has repeatedly emphasised to the government that smoothing the economic cycle needs excessive spending to be avoided in good times and large investments to be postponed to times of crisis. Mr Hansson says that Estonia’s reserves are needed not just for surviving any future recession but also for coping with a shrinking labour force and the decline in the amount of money coming from the European Union.

Ardo Hansson, you have said several times when criticising the structural deficit in the Estonian state budget that if we cannot build up our reserves in the good times when the economy is growing by 5% and all other circumstances are good, then when will we be able to do it. But when then should we spend these reserves? During the last crisis, spending was cut sharply and no large investment was made.

Our reserves certainly did help us during the last crisis. Cuts had to be made but quite a large part of our reserves was brought into play. It was hard to borrow at that time. Although Estonia’s debt was very small, the markets did not trust Estonia and the interest rates at which it was possible to borrow money were very high.

The reserves proved their worth in cushioning the blow.

The average citizen would say you should keep three months of wages on your bank account to cover for unexpected events. How much should the Estonian state hold in its reserves?

The Estonian state has something in the region of three months of cover, but this is not a hard and fast rule.

We are not currently looking only at cyclical factors but also at long-term trends. The second reason for building up the reserves is the money from we get from the European Union, of which there will be less in future. So if we want to think about living on borrowed funds, this should be more a question for the future. The third point is demographics. We can see that in future there will be fewer and fewer workers and more will need to be spent on healthcare and pensions.

So reserves will be needed, especially in Estonia. Our future is not as rosy as those in some countries where demographics are more favourable.

You have said that the construction sector is overheating. Do you think that large investments should be postponed because of this, regardless of whether they are funded with loans or from reserves?

The government should decide for itself how to bring its budget into a moderate surplus. One way of doing that is of course to find some investments that could be postponed. If the investment has already started, then it should be seen through to the end, but new investments that are not very critical could perhaps be delayed by a couple of years.

The government makes up a very large part of the total economy and it needs to play a balancing role. If this can’t be done through investment, it may be necessary to review some current spending, which in some ways is a bit harder.

So it is worth being careful right now.

Very careful.

Is the economy clearly overheating? That might be overstating it, but there are more and more signs of it and they are concentrated in the labour market, where unemployment is low, wages are rising fast, and the number of vacant jobs is rising. Employers in most regions are already having problems finding good employees. If we pour oil onto the fire in this circumstance, by wanting to spend more, say, when it is not possible to find any employees, we will provoke inflation, which is no good for us.

Secondly, if construction prices start to rise, some companies that are planning investment may rethink as their projects become too expensive. From the state’s point of view it is very good that something is being done, but the unseen consequence is that some spending by the private sector does not happen. The net result is that no great impetus is being given, but simply that the state is crowding out the private sector.

You have been involved in central banking for a long time. Has there ever been a time when central banks are not calling for caution?

I find that rather unlikely in a state that is functioning well, though during the last crisis there were moments when some central banks whose national economies were in recession said that wages could rise a little faster. It is not impossible. Historically we have got used to inflation threatening to rise, and it is our goal to bring it down. Things have been a little different in the past decade, as we have tried to encourage inflation. This is quite unusual. Some central banks have expected that stimulus to come from elsewhere, either by the state helping a little or by higher wages being paid in the private sector.

The euro area is currently trying to raise inflation a little, but you say that wages in Estonia should not rise so fast. This seems completely unacceptable to most people, who want their wages to rise and there to be no inflation.

Yes, it is paradoxical sometimes. The main target with inflation is for it not to be too high, but central banks have also seen from historical experience that it can also cause problems if inflation is too low. If deflation takes hold, prices start to fall, businesses become pessimistic and negative developments occur. It appears to be best when inflation is below 2%, as this is moderate and positive.

The main issue with rising wages is that they should rise sustainably, in line with the growth in productivity. Then of course everybody is happy and that is what we are trying to achieve, for wages to be as high as feasible. But historically there have also been times when hindsight showed that wages had risen too high and so a country lost its competitiveness. This leads to other scenarios, where economic growth is non-existent or very low. This is something that happened in Finland a few years ago.

If the Estonian economy were a porridge pot that could be heated from zero to ten, at what temperature are we currently simmering?

I believe we are already in the higher part of the temperature range, though we are not yet close to what happened here in 2006–2008. That was the full heat of the desert. We can see now that things are getting hotter and hotter. I cannot give any exact numbers but the temperature is already too hot. It should be reduced gently so that development in the future would be sustainable and we would avoid getting caught in too much of a boom and bust cycle. Things are already so good and we could make them even better by pouring oil on the fire, but it is the future that would pay the price.

It is often said that if a company or part of the economy is not able to pay the wages that the market demands, then perhaps it has no business being in Estonia.

If the rest of the economic environment is sustainable then this is true. Companies make their choices irrespective of the development of the economy.

The second possibility is that the whole market, the economy as a whole, has reached a stage where the numbers just do not add up at the end of the day. We already know there will be some sort of slowdown ahead.

You highlight above all the overheating of the labour market, but one of the main indicators of success for companies has been how many new jobs they can create. Should we be using some other yardstick and looking for example at value added or new technologies?

The Estonian labour market has worked wonderfully in recent years. The rate of employment is very high and very many of those who want to work have already found a job, and if we compare our figures with those of other European countries, then ours are the best. But if we look at demographics, where the outlook is not so good, then we may ask how much more employment can increase.

Employment will start to make a smaller and smaller contribution to economic growth and in some years time it may even be negative. In this case it may indeed be necessary to start measuring investment or productivity. Fetishising employment when the resources of employment are more or less used up ... we could indeed consider some other yardsticks.

How much of a worry are labour shortages in the long-term? If we look at how much is already automated, then maybe we will soon have the opposite problem again.

I think this development is more of an evolution. The tensions from technological development are much greater in countries where the population is growing very fast. If we are smarter then this should be a solution we do not need to fear as we already have labour shortages. Part of this is cyclical and will fade away, but some shortage of labour is a permanent feature as our demographics are what they are.

The European Central Bank has stoked the heating of our economy a little through low interest rates and bond purchases. Bond purchases are starting to be reduced though, and although interest rates should remain low at least until 2019, we do not know what will happen after that.

That is right. We need to look at the overall figures for the euro area. We cannot calibrate them so that we touch the brakes a little for some country which is doing a bit better while stimulating some other country that has fallen a bit behind. If we have decided that we are having a single monetary union, then we have to look at the overall figures for that monetary union.

The situation has been quite good in Estonia for some years now, but unemployment was high in the euro area as a whole until recently, and the output gap was negative. In these circumstances inflation was low and the economy needed stimulating.

Things have improved now and the economy in the euro area has been growing by a little over 2.5%, which is quite fast for the euro area. It is not easy for wealthy countries to grow so fast. For this reason we have started to reduce our asset purchases. At one point we were buying 80 billion euros worth each month, but now it is down to 30 billion. We have said we will continue at this rate until September, and what happens next will depend on how inflation develops.

No decisions have been taken but we have said that the first step in ending this policy will be to reduce asset purchases, and once they have come down to zero then sometime in the more distant future, interest rates may start to rise.

The markets expect that interest rates may start to rise a little by the middle of next year. We at the European Central Bank still need to look directly at actual developments. Once we are certain that inflation is rising moderately, the policy of purchases may be ended a little more quickly.

Rising moderately, is that up to zero, or positive, or…

If we are talking about the longer future, then I would like to believe that the new normal for interest rates would still be positive. I would not want to speculate how precisely to get there, over several years, but I certainly do not believe that interest rates could remain negative permanently.

Looking at the history of Europe it appears that the usual interest rate for people with housing loans is very different from what it is now. Will we get back to this point?

Whether we will get back to the historical average level I could not say. But if someone takes out a housing loan they should remember that interest rates will not stay forever where they are now.

If everything is now so good, with the economy growing throughout the euro area and inflation at an appropriate rate, why should money printing even be stopped at all? Keep it going if it is working.

We would not want things to swing over to the other extreme. If labour shortages were to become too large in the euro area, wages and prices would start to rise rapidly and this would cause problems. Inflation is currently around 1.5%. It could be a little higher, and we would hope that sooner or later the economy would be able to generate inflation of little below 2% all on its own. It is not really right for an economy to be dependent on stimulus.

Then it becomes very difficult to find anything to stimulate it with.

If we look at where we are now with things in quite a good position, and ask whether it is time to start building up policy space against any future crisis or to stimulate the economy further, then I would suggest the argument is moving more in favour of building up additional policy space.

Have we rebuilt sufficiently well after the previous crisis? Not so much in terms of reserves but in improving legislation and systems.

A lot has been done. The banks in the euro area are in a much stronger position and mechanisms have been set up for crisis resolution and the reorganisation of banks. The institutional basis is much stronger.

One danger is that we start to forget the lessons of history. This may not affect the euro area so much, but in some other countries it is starting to be asked whether we have not done too much to regulate the banks. What could go wrong if we started to liberalise a little again...

How dangerous are political measures? Has there ever before been a government in the euro area that has said clearly that perhaps it should leave the euro? I am thinking of the new government in Italy.

We will see. It is difficult to speculate about Italy and what exactly will happen there. We have seen what is called populism of that sort before. The combinations have been different, but there is often a gap between the initial rhetoric and the later reality. The markets make things clear fairly quickly. If somebody today introduces policies that the markets view askance, it is immediately reflected in the interest rates that the government is charged by the money markets for any new loans.

Another thing is what we were just talking about, that the whole system has a new basis. Six or seven years ago it was quite common that if some member state started to face problems, this immediately impacted the condition of other states. I would like to believe that we have done enough work in different areas to ensure that those problems remain more and more a problem only for the country affected.

To give a very specific example, when we started the asset purchase programme we set the important principle that the central bank of each country buys securities from its own country and the risks are not shared. So if some government started to introduce policies that were not ultimately sustainable, it would be its own central bank that suffered. Such a government would be shooting itself in the foot.

In the last crisis many very old banks fell into difficulties and some of them were even closed. Now there are new actors in the financial world, who combine IT and finance. Even our own TransferWise is promising to launch a revolution. What changes will we see in this area?

This is a new and exciting area and one of the main strands in the new strategy of Eesti Pank.

If they make it possible to improve our circumstances without overly increasing risks, we are quite prepared to support such solutions and help them. We must remember though that risks can arise because these new actors are very lightly regulated.

The overall picture is quite spotty. Some small firm looks at a part of the market, such as payments, and decides that banks are earning too much from them and the payments are too slow. So they provide cheaper and faster payments. This of course undermines the income of the banks and makes their lives much harder. Overall though it is a positive development when competition arises, as prices fall and consumers get access to new types of service.

The second dimension is global platforms, which I believe are a much greater challenge as the risk arises of monopolies being created. New opportunities arise in the short term, but if platforms from America and China come to dominate one day and all others are pushed to the side, this is not very good either. Then fees would start to rise again. There are also new developing technologies.

The traditional media has already had the painful experience of social media giants and search engines taking a large part of our advertising money, while regulators say there is nothing much they can do as it has already gone too far. Could the same thing happen in the financial sector, where controls have historically been much tighter, so that at some point one institution is so large that it can no longer be controlled?

There are certainly some risks. The amounts of money that currently move through what are known as fintech firms are quite small. The growth has only been a little faster in payments, and there is already discussion about whether that should start to be regulated to some extent.

When we have global companies, we need global solutions. The world has already seen in other areas that when such challenges arise, it is possible to agree general rules of the game on a global level, whether that is at the IMF or through the G20.

There is still some danger in those areas where finally one or two winners may emerge that start to become very dominant. We should be ready for this and should discuss it both within central banking and elsewhere.

What do you think about bitcoin? Is it a danger or an opportunity?

It is more of a danger. I myself am not very impressed about it, but it is currently a hot niche topic. Those who follow such things are very passionate about it because it involves new technology.

Does it represent a paradigm change? I find it hard to believe that some money issued by the private sector or by nobody could start to affect traditional currencies or compete with them significantly.

From the average person’s point of view, why do I need bitcoin, what problem does it solve, what is wrong with the money we have at the moment? I have not heard any good answer to that.

We are now moving towards having instant payments within Europe. It is a question of months, or a few  years, then it will be possible to make all sorts of payments using the euro in less than ten seconds. So if you have proper money, inflation under control, payments moving rapidly, and a strong banking sector… I cannot see how there would be any future in competing with such a system. I do not see any great future for cryptocurrencies.

There is no need for an estcoin alongside the euro?

Certainly not. There are several variations in the estcoin proposal where the money aspect was not dominant. We do not comment on that. If the state believes it needs some sort of token to monitor participation in some process then that is one thing. But Estonia starting to issue a parallel currency is something that certainly will not happen.

Nobody is really able to understand what there is behind a cryptocurrency to guarantee it. What is there behind the euro?

Ultimately it is based on its history of trustworthiness. The central banks have been able to demonstrate that they take their mandate seriously, they are able to ensure the value of the currency, to raise inflation in difficult times and to calm it down in the good times. It is hard to beat a well managed currency.

Bitcoin attempts to increase its trustworthiness with complex formulas, which require large amounts of electricity to solve. So it needs massive amounts of physical resources just to reach the same level of trust that well-run central banks already have.

If we were a central bank that had historically had problems and was not able to cope with inflation – and there are such countries – then the question would be more understandable. But currencies like the euro, the dollar and the Japanese yen have earned trust. Some conspiracy theorists say that central banking is the devil’s work, but they are a very small minority.

The interview was conducted by Hans Väre, newspaper Sakala.

Published date: 
06.06.2018
Published in: 
Newspaper Sakala