You must be one of the most sought-after interviewees for reporters covering financial affairs. How often do the interviews you do include the claim that the ECB has done too little, too late?

First of all, I do not give that many interviews, while I'm thrilled to give an interview to you and to communicate with the Estonian people. I'm delighted to be here and think it is an excellent opportunity to explain what the ECB can do.

How often am I asked this [question]? Probably as often as the opposite. Because what we have to do at the moment is difficult. We have to bring inflation back to 2 percent in the medium turn. That's our objective, our primary concern, our compass. We are facing, throughout Europe, in the euro area and in Estonia in particular very high, too high inflation. It is double the Eurozone average in your country and something that people want to see go down, so that prices wouldn't be as high and so wouldn't continue getting higher.

You know better than anyone that inflation has been above 2 percent since July of 2021, and yet, the ECB didn't react for a whole year. Why is that?

I would disagree with you, respectfully. We actually started acting against inflation in December of last year, though not in July. Why is that? Because we had multiple tools in action and you cannot stop all tools at the same time without risking financial instability.

We started by terminating the earlier pandemic emergency purchase program. We then stopped the net purchases under the asset purchase program, and very shortly after that, we pulled out of negative interest rates. Three tools in a row were stopped one after the other. And we did not experience financial instability.

And within a matter of a few months, we increased interest rates by 200 basis points. So, out of negative territory where we had been for many years, and into positive territory rapidly, frontloading the exercise of normalizing monetary policy. We've been at it since last December.

And yet, we are now experiencing a perfect storm. Inflation in the Eurozone is measured on average at 10 percent, In Estonia, it exceeds 20 percent, and this is all around the Baltics. We have an energy crisis partly or mostly affected by manipulation of prices by the Kremlin. How does raising interest rates affect energy prices and the energy war with Russia?

What would affect energy prices more than anything else would be restoring peace, making sure borders are respected in the future and not weaponizing energy. What we, as central banks, have to do is make sure that we do not stimulate demand as we have done and had to during the Covid crisis. And that we really make sure than inflation expectations remain anchored. So, people would know that in the medium term inflation will be declining in the next couple of years, and that we will bring it back down to 2 percent. Because if people were to assume that we are in this sort of matter-of-fact, business as usual inflation trend, that would be terrible. It would be entrenched and embedded in behavior and consumption, and it would be very dramatic for our economy. We are not going to bring the price of petrol at the pumps down next week. We are not going to smooth out the supply bottlenecks in the next month. What we are doing takes time.

But Estonian households that spend a large part of their income on energy already have another problem now in rising Euribor. Therefore, I'm not sure many people who have normal jobs understand why the ECB has to hike the rates now. Could you explain that for the ordinary person?

If we did not fight inflation, it would linger and prices would continue to go up and up. That is not what people want. People want stability of prices, to know where to invest, whether they can keep their job, employ somebody because prices are stable. That is what we need to restore. Of course, there is no smooth easy solution. You have to use the most useful tools, and at this junction, interest rates are the most important and efficient tools to bring inflation down. If you had to choose between higher inflation for a very long time and higher interest rates and inflation coming down, which would you choose? Probably the latter. It will take time.

How long will it take? And how high are you expecting interest rates to go? 3, 4, 5 percent?

Regretfully, I cannot give you a number as I don't know what that number will be. What I know is that it has to be enough to bring inflation back to 2 percent. And that will depend on the inflation outlook, economic circumstances, the time it takes for monetary policy to impact the economy. That will be determined, meeting by meeting, by all the governors around the table and looking at all the data we have available. All I know is that it will have to be more than what we have at the moment.

The cost of borrowing has increased dramatically for the Estonian government, even though we have kept our house more or less in order. Now, we have to pay for the risk of having Russia as a neighbor. Can the ECB do anything to mitigate that risk?

The best solution would be a peace settlement and fairness. This is not something the central bank can provide, unfortunately. We can wish for it. It is for governments, diplomats and everyone involved to take action.

Thinking back to the financial crisis more than a decade ago, the ECB stepped in to finance the governments of southern European countries when they were in trouble. Could a similar solution be imagined in eastern Europe for governments that are suffering simply because we are situated next to Russia?

We could discuss the past, but let us look at the current situation. If we were to see risk of fragmentation, monetary policy decisions not transmitted throughout the euro area – from here in Tallinn all the way to Malta – and it was not caused by fundamentals...

Our inflation is double...

...then we would have the tools to make sure that monetary policy is transmitted throughout the euro area. We have the flexibility in reinvestment of PEPP, and more importantly we have the transmission protection instrument, which would enable us to defeat disorderly market dynamics not based on the fundamentals of the economy. That's a tool that could be used in the case of the Baltic countries if the conditions were satisfied.

But that's not the case here, even though our inflation is double the Eurozone average?

It's not intended to focus on one particular inflation level in one particular country. It's intended to focus on and target market dynamics that would be disorderly.

We are entering a period of stagflation. Would you say that the central bank is at least partly responsible?

The ECB has to focus on its mandate. The European Treaty has told us to maintain price stability. We have defined it, as have many other countries in the world, at symmetric 2 percent in the medium term. And this is what we have to do.

What about a decade of government bond purchases, printing money as it is referred to? Did the ECB take it too far?

The ECB deployed all possible tools available in order to deliver on its mandate. Remember those days. We were not fighting 20 percent inflation in the Baltics. We were facing the risk of deflation. Everything was used at the time. Negative interest rates that were pretty much unheard-of, purchase programs that were called for in order to really combat risk of deflation, and we did not see deflation. Inflation was not at 2 percent but at least it was maintained at those levels. Additionally, the euro area stayed together and the risk of fragmentation was avoided.

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