Good morning. Let me begin by thanking the organisers of this seminar for the opportunity to speak on such a distinguished panel.
I’d like to elaborate on two challenges. The first is domestic and concerns how we, as Euro-area central bankers, decide and communicate about the gradual normalisation of our monetary policy in uncertain times. The second challenge is a collective one: how we co-ordinate facing diverging economic paths.
The Euro-area is experiencing a broad-based economic expansion. Q2 2018 was the 21st successive quarter of economic growth. 9.2 million jobs have been created since 2013 and the unemployment rate has fallen from 12.1% to 8.1%, although this figure is still too high. There are increasing signs that the labour market is tightening and nominal wage growth is picking up: the Phillips curve is back to work, albeit a bit later than expected. The output gap was probably closed by the end of last year. We are increasingly confident in the sustained adjustment in inflation back to our objective, with our forecast for 1.7% in each of 2018, 2019 and 2020, vindicating our unanimous decision in June to pursue a course of gradual normalisation.
There are, however, growing uncertainties: protectionism could weigh on business confidence and investment; many EMEs are struggling with the US policy-mix – a warranted monetary policy normalisation, having to cope with a less warranted fiscal stimulus; and financial market valuations that remain stretched despite the recent correction. Within Europe, Italian fiscal policy is under investor scrutiny. And there is Brexit, although its direct effect on the euro area macroeconomy is likely to be small.
How should we respond to this uncertainty? By combining two apparently contradictory aims, clarity and flexibility:
Clarity – Our first duty as policymakers is to provide markers to help guide economic actors and financial markets in the increasing fog of uncertainties. For our guidance to be reliable, we need to be as clear, credible and consistent as possible. We cannot be clear like a train timetable but more like how a captain sets a course and adapts to the wind and the waves. So our sequence of steps for policy normalisation is very predictable: first, we halved our net asset purchases to 15 billion this month and will very probably end them in December. Second, we set down a guide post with our long-dated forward guidance: we will maintain interest rates at current levels until at least through the summer of 2019. And third, we will retain our stock of assets for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation. Moreover, this sequence doesn’t depend on the fiscal uncertainties that can appear in member states. The Governing Council is clear about the fact that there is no fiscal dominance in the euro area and no influence of any national fiscal policy on our common monetary policy.
Flexibility – Our sequence is clear but the details of implementation are flexible and state-dependent. We have included several options to deal with incoming data. Let me illustrate this on two points:
In the face of uncertainty, one often hears reference to the celebrated Brainard[i] ‘conservatism principle’ (as reinterpreted by Alan Blinder[ii]). This is not, as the impression is sometimes given, a general warning to move cautiously when the world is uncertain. The Brainard ‘conservatism principle’ says only that you should move cautiously if you are uncertain about the effect of your policy instrument on your objective. But we should go beyond a static view of Brainard’s principle (which focuses on one single small step): a dynamic view would include the time dimension and consider how to manage and communicate a sequence of incremental steps.
The global economy continues to expand strongly but we are now seeing a strong divergence in performance. We have used a lot in the latest IMF-WEO forecasts, the nice French word « plateau » to describe global growth. But this “plateau” is not even: a strong acceleration in the US, even if it is temporary and fragile, offset by a moderation in growth in the rest of the G7. Some prominent emerging market economies are either expected to slow down rapidly or record only modest growth. In short we are moving from synchronized growth to economic divergence.
In many cases, this divergence reflects differences in the economic cycle and idiosyncratic shocks. More worryingly, from a systemic point of view, however, is that some countries might be suffering from the ongoing rise in US interest rates. Helene Rey’s famous paper in 2013[iii] argued that floating exchange rates are not sufficient to give countries independence from US monetary policy if they have an open capital account. If the trilemma is in fact a dilemma, then countries will have to choose between monetary independence and closing their capital accounts.
I would contest the generality or starkness of her dilemma. For example, I think the euro area can determine its own course. Our asset purchase programme has contributed to a spread exceeding 250 basis points between the 10 year yields in the US and in Germany. Likewise, the gap between policy rates in the US and the euro-area is the widest since 2009. More technically, an estimated Taylor rule for the euro area that includes US monetary policy as one of the explanatory factors finds only a very modest co-movement between the two.
Countries instead seem to be arranged along a continuum, with some exhibiting total independence at one end to those with exchange rates pegged to the US dollar at the other. Countries don’t have to choose one of the two polar positions but can pick an intermediate position. For example, putting some temporary restrictions on cross-border movement of capital could give some but not complete independence of monetary policy.
But is there more that we can do to manage the tensions created by this economic divergence? Put another way, how do we reconcile yet another paradoxical couple: independence and co-operation?
Obviously the question is not to go back to a world of accords negotiated in hotel suites. But we can and should act to enhance co-operation between central banks. Such co-operation includes four elements:
So, in conclusion, we as central bankers should be predictable without being pre-committed. In other words, we should give clarity without pretending to certainty. Voltaire summed this up nicely in 1770: “Doubt is an uncomfortable condition, but certainty is a ridiculous one.”[iv] In these times of doubt, the Governing Council of the ECB is committed to give as much clarity as possible; clarity, not certainty, which is neither possible nor desirable. Thank you for your attention.
[i] Brainard, W. (1967), « Uncertainty and the effectiveness of policy » the American Economic Review, Vol. 57, No. 2, Papers and Proceedings of the Seventy-ninth Annual Meeting of the American Economic Association, May, pp. 411-425.
[ii] Blinder, A. (1999), Central Banking in Theory and Practice, the Lionel Robbins lectures, MIT Press, Cambridge Massachusetts.
[iii] Rey, H. (2013) “Dilemma not Trilemma: The global financial cycle and monetary policy independence”,
Jackson Hole conference proceedings, Kansas City Fed.
[iv] Letter to Frederick William, Prince of Prussia (28 November 1770).