Incoming ECB chief Christine Lagarde elaborated officially on her views about European monetary policy for the first time since being tipped as Mario Draghi’s successor.
“Current inflation levels and the outlook on inflation as contained in the recent Eurosystem staff projections are not in line with the ECB’s inflation aim”, she said, in written answers to a European Parliament questionnaire, adding that “in the wake of global headwinds weighing on the euro area economic outlook, it remains appropriate for the ECB to provide an ample degree of monetary policy accommodation to support the expansion of the economy and the convergence of inflation to its aim in a sustained manner”.
Largarde takes the reins at a crucial juncture and will immediately be faced with the Herculean task of rescuing Europe from a deflationary spiral or, more colloquially, from “Japanification”.
Read the latest on the ECB’s hotly-anticipated September meeting
Her responses span some 50 pages (you can read and download the full .pdf below), but the general thrust is that Largarde, as widely expected, is set to carry on Draghi’s legacy.
“The latest decisions of the ECB’s Governing Council such as its forward guidance on interest rates are in my view correctly aimed at preserving the very accommodative financing conditions for firms and households that are needed to support economic growth and ultimately, push inflation higher”, she remarked, in response to a question about the appropriateness of recent ECB decisions.
On the possible side effects of extraordinary policy, Lagarde said low rates together with the other monetary policy measures adopted “have contributed to the disappearance of deflationary risks and to supporting economic growth and employment creation”. That said, she acknowledges the myriad associated pitfalls, including those related to financial stability.
When asked about the “sequencing and timing” of policy normalization, Lagarde essentially said it’s too early to have the discussion beyond what’s been communicated in the forward guidance and reinvestment plan for the central bank’s portfolio. “In taking monetary policy decisions, both domestic and international economic and financial data must be thoroughly analysed”, she said, adding that “monetary policy should remain data-dependent and should be guided by the euro area inflation outlook”. In light of that outlook, “policy normalisation is premature”, she wrote.
As far as the “distortive” effects of corporate bond purchases, Lagarde deferred to CSPP guidelines. “The broad range of bonds eligible for the CSPP supports the effectiveness of CSPP as a monetary policy tool, while maintaining a level playing field for all market participants and avoiding undue market distortions”, she said, parroting the official line. Obviously, there have been no shortage of “undue market distortions”, both from CSPP and APP. In fact, there’s a sense in which liabilities can now be viewed as “assets” by corporate management teams, thanks to €1.1 trillion of negative-yielding corporate debt in Europe.
(BofA)
In any event, you can read some passages below and the full remarks (.pdf form) are embedded at the tail end.
Remember that when it comes to Lagarde, the ECB will get a seasoned political operator and something of a consensus builder. That may prove especially useful going forward in the event the eurozone economy careens into a downturn, raising the stakes in contentious relationships between, for instance, Rome and Brussels.
From the European Parliament
1. Please highlight the main aspects of your professional skills in monetary, financial and business matters and the main aspects of your European and international experience.
My professional experience spans over the last four decades and developed in this unique blend of private sector experience (as a practicing attorney and as an executive, at the American law firm Baker McKenzie 1980 to 2005), and of public policy leadership positions both domestically (as Trade Minister and Economy and Finance Minister from 2005 to 2011), and internationally (as Managing Director of the International Monetary Fund from 2011 to present time). As French Minister and member of Council of the EU, I was moreover directly involved in EU decision making.
In all these positions I have been exposed to business and financial matters. All my clients were large corporate entities when I was an attorney. I also gained substantial exposure to the financial community either when I was Minister of Economy and Finance or as Managing Director of the IMF. In all these positions I have operated in a domestic and international setting both in private and public sector; my working language has been English for the last 40 years or so with the exception of my six years in the French government.
I gained multifaceted experience ranging from tax and antitrust, labour and mergers and acquisition practice, to financial crisis management at the national and international level during the global financial crisis. My most recent professional experience as Managing Director of the IMF drew on the unparalleled triple mission (i) policy guidance and economic monitoring, (ii) crisis management and lending programmes, (iii) training and capacity building. In all these positions I had regular exchanges with policy-makers at the highest level, and was able to leverage those relationships for the benefit of the institutions I lead over the years. The professional experience thus gained has allowed me to develop a comprehensive understanding of the European and global economies as well as international standing. My experience of heading a big international organisation like the IMF further underlines my ability to listen to staff and stakeholders, shape a common and modern vision, take a collegial approach and strive to build consensus to achieve better outcomes.
2. Do you have any business or financial holdings or any other commitments which might conflict with your prospective duties, and are there any other relevant personal or other factors that need to be taken account of by the Parliament when considering your nomination?
When becoming Minister of Trade in 2005, I had stepped down from any alternative and possibly conflicting positions such as a board member of ING or other Baker McKenzie-related entities including member of the board of the European Law Centre that I had set up in 1995. Subsequently, I only accepted honorary positions such as advisory board member of Robinson College in Cambridge, and honorary board member of Holton Arms School in Washington, with the prior approval of the Ethics Committee of the IMF Board.
In addition, I have consistently defended the cause of women whenever there was discrimination and inequality. I intend to continue doing so and would expect that it would not impair my authority to speak on monetary matters nor would it distract me from discharging my duties to the best of my abilities. The same is true in relation to climate change issues and the protection of our environment.
3. What would be the guiding objectives you will pursue during your eight-year mandate as President of the European Central Bank?
The primary objective of the ECB is to maintain price stability, and it will have to do so in a domestic and international environment that has significantly evolved over the last ten years. This environment, in its advanced economy parts, is characterised by moderate growth and low inflation. And while the financial sector is safer and better regulated than it was before the global financial crisis, slow growth and low inflation will be a challenge for financial intermediaries whose business models have been established in a dynamic-growth, high- inflation world. Furthermore, new and often disruptive technologies are transforming the way in which the economy operates. International cooperation is called into question, the environment is under threat of climate change and extreme weather developments and in many parts of the world populations are rapidly aging.
In this context, the ECB will need to continue to carefully monitor and analyse economic and financial developments in Europe and around the world. If appointed ECB President, I will foster such alertness to the new trends within the institution and encourage analysis to study them. I will seek to develop consensus within the Governing Council and would endeavour to communicate as clearly and simply as possible both the strategy and the policies of the ECB in a complex world bearing in mind its multi-layered and multi-cultural audiences ranging from European citizens to financial markets.
My ultimate premise is that the euro is a European public good that should continue to improve its international standing. A strong institutional architecture of the Economic and Monetary Union (EMU) and a determined ECB focused on delivering price stability are key in this for the benefit of all.
4. What is your assessment of the ECB’s monetary policy as it has been implemented over the last 8 years? What changes, if any, would you promote when becoming President of the ECB?
The primary objective of the ECB is to maintain price stability in the euro area. The ECB has defined price stability to be a yearly positive inflation rate of below 2% and has declared that, in pursuing price stability, it will aim at an inflation rate below, but close to, 2% over the medium term.
The ECB has faced a very challenging environment over the past 8 years. In response to the financial and sovereign debt crises, the ECB took a number of measures that were pivotal in safeguarding the monetary policy transmission mechanism, supporting the euro area economy and ultimately steering inflation towards levels that are more in line with its policy aim.
In particular the easing measures deployed since June 2014, including targeted longer-term refinancing operations, negative rates, large-scale asset purchases and forward guidance, were successful in fending off the risks of deflation and redenomination at the height of the crisis. In June 2014, headline inflation was well below 1% and declining. Today, headline inflation is expected to be 1.3% in 2019, 1.4% in 2020 and 1.6% in 2021. The euro area has seen continuous economic growth for the past six years, and unemployment has fallen to the lowest levels since July 2008. The progressive tightening of the labour market is a signal that the policy measures of the ECB create the necessary conditions for inflation to keep strengthening.
Overall, considering the past eight years, I would say that the monetary policy of the ECB has been effective and successful. According to ECB calculations, over the period 2016-2020, growth and inflation would have been around 1.9 percentage points lower in the absence of the ECB’s actions taken between mid-2014 and mid-2018. At the same time, however, inflation has been persistently below levels that are consistent with the ECB’s inflation aim over recent years. The euro area economic expansion has also slowed of late and the risks surrounding the growth outlook are tilted to the downside. It is therefore clear that monetary policy needs to remain highly accommodative for the foreseeable future.
Looking ahead, it would be worth collecting lessons from the financial crisis as regards changes in the macroeconomic environment and inflation process. This could inform future reflections on the conduct and operational aspects of the ECB’s monetary policy, also considering how it can best support the general policies in the European Union, such as sustainable and inclusive growth, without prejudice to its primary objective of maintaining price stability. In addition, changes in the regulatory environment and in financial intermediation over recent years may warrant a review of the operational framework of monetary policy. Along with other central banks, the ECB made a lot of adjustments to the way it implements its monetary policy in response to the financial crisis and market practices. Consideration should, therefore, be given to the way monetary policy will be implemented in the longer run, including size and composition of central banks’ balance sheets and the choice of policy instruments.
5. What are the main risks/opportunities ahead for the euro? What do you see as the most important risks and challenges facing the ECB?
The current macroeconomic and international environment presents a key near-term challenge for the ECB. The euro area growth momentum has slowed and the balance of risks to the growth outlook is tilted to the downside. Inflation remains subdued. It is therefore clear that monetary policy needs to remain highly accommodative for the foreseeable future. The ECB has a broad tool kit at its disposal and must stand ready to act. The precise mix of instruments deployed will have to depend on the nature of the shocks affecting the outlook for inflation as well as on financial market conditions. While I do not believe that the ECB has hit the effective lower bound on policy rates, it is clear that low rates have implications for the banking sector and financial stability more generally. So it will be essential to closely monitor whether adverse side effects may emerge in the future, the longer low interest rates are in place.
Furthermore, the ECB is faced with a growing number of structural challenges and will also have to manage expectations about what it can and cannot do to maintain trust in policies. While monetary policy is an effective tool for stabilising the economic cycle, it cannot lift countries’ longer-term growth potential. In other areas and where new challenges arise — ranging from digitalisation and cryptocurrencies, cyber security and anti-money laundering (AML) to climate change — it will have to clarify how these affect its operations and how it can contribute.
As regards the euro, the institutional architecture which started to be put in place during the crisis — notably comprising the banking union, the European crisis management framework and the capital markets union (CMU) — remains incomplete. The euro area architecture also still lacks a central fiscal instrument for macroeconomic stabilisation. Progress in these areas will not only make the euro area more resilient, but also supports the effectiveness of monetary policy and the international role of the euro. One of the important lessons of the first twenty years of the euro is also that seizing the opportunities from the single currency requires sound national economic and fiscal policies, in the interest of both the Member States concerned and the euro area as a whole.
6. The Federal Reserve and the Bank of Canada have recently announced a review of their monetary policy framework. Twenty years after the introduction of the euro, do you think the time has come for conducting a similar review at the ECB?
In general, the monetary policy strategy should always evolve in a way that best serves the ECB’s mandate. As quite some time has passed since the last strategy review in 2003, it would be worth collecting lessons from the financial crisis as regards changes in the macroeconomic environment and inflation process. It could also consider how the ECB’s monetary policy can best support the general policies in the European Union, such as sustainable and inclusive growth, without prejudice to its primary objective of maintaining price stability.
As regards the monetary policy implementation or operational framework, central banks have made a lot of adjustments to the way they implement their monetary policy in response to the global financial and economic crisis, in particular by introducing unconventional measures. But also financial markets have undergone significant changes, driven by developments in the regulatory environment, market infrastructures and financial intermediation. In this context, it will be important to also review how to operate and implement monetary policy, in particular to consider what elements should be retained in the longer run. In view of the fact that intermediation in financial markets and the regulatory setting have changed, operational frameworks are likely to look different than those before the crisis, including the size and structure of balance sheets and the instruments with which to implement the monetary policy stance.
7. How should the ECB conduct its monetary policy in the current macroeconomic conditions? How do you see the ECB’s performance regarding the achievement of its primary objective of maintaining price stability? What do you think about recent suggestions to interpret the 2% inflation target as a symmetric target? What do you think about calls for adding financial stability or asset price inflation as a second objective of the ECB’s monetary policy?
The ECB policy reaction has been very forceful in combatting the risks of deflation that started to emerge in 2014. When the ECB launched its comprehensive policy package, in June 2014, headline inflation was well below 1% and declining. Today, headline inflation is about 1% and the June Eurosystem projections foresee it to be at 1.3% in 2019, 1.4% in 2020 and 1.6% in 2021. The probability that financial markets place on deflation has also declined relative to peak levels, and unemployment has fallen to the lowest levels since July 2008. The progressive tightening of the labour market is a signal that the policy measures of the ECB create the necessary conditions for price pressures to keep strengthening.
However, current inflation levels and the outlook on inflation as contained in the recent Eurosystem staff projections are not in line with the ECB’s inflation aim of “close to, but below, 2%”. Hence — and also in the wake of global headwinds weighing on the euro area economic outlook — it remains appropriate for the ECB to provide an ample degree of monetary policy accommodation to support the expansion of the economy and the convergence of inflation to its aim in a sustained manner. In this regard, the recent clarification that the ECB’s inflation aim is symmetric is important. It implies that the ECB is as committed to fight inflation above its inflation aim as it is to fight inflation below that aim. In fact, inflation can deviate from the aim in both directions, so long as the path of inflation converges back towards the aim of “below, but close to, 2%” over the medium-term policy horizon. It thus underlines the ECB’s determination to pursue its inflation aim over the medium term.
At the same time, while the ECB should maintain an accommodative stance, other policy areas must contribute more decisively in order to reap the full benefits from the monetary policy measures.
As regards the introduction of additional objectives, the Treaty on the Functioning of the European Union clearly establishes price stability as the primary objective of the ECB. While price stability and financial stability are inherently interlinked and tend to be mutually reinforcing, two different objectives warrant the use of two different sets of instruments. The objective of monetary policy remains the safeguarding of medium-term price stability. The main task of macro-prudential policy is to address risks to financial stability to increase resilience of the system against shocks and to ultimately curb the financial cycle, so that the risk of financial crises occurring is reduced and real economic effects of financial crises are dampened.
In general, the two policy areas interact, and their effects on each other have to be considered. Macro-prudential policy influences credit conditions, and thereby also feeds back into the overall economy and, hence, the outlook for price stability. Monetary policy can, in the pursuit of price stability, affect financial risk via a number of transmission channels. Therefore there are positive synergies of having monetary policy and macro-prudential policy within one institution.
8. What is your view on the latest decisions of the ECB Governing Council, in particular concerning forward guidance on key interest rates which are expected to remain at the current level at least until the first half of 2020?
Economic growth in the euro area has been moderate while persistent uncertainties — mainly related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets — have been weighing on economic sentiment. As a result, inflationary pressures have remained muted and both realised and projected inflation rates have been persistently below the levels that the Governing Council considers as being consistent with its aim.
Against this background, the latest decisions of the ECB’s Governing Council such as its forward guidance on interest rates are in my view correctly aimed at preserving the very accommodative financing conditions for firms and households that are needed to support economic growth and ultimately, push inflation higher.
In particular, the decision to adjust the forward guidance on key interest rates provides accommodation through better anchoring market expectations about the expected interest rate path and lowering uncertainty. There is a date-based element in the forward guidance formulation — that interest rates are expected to remain at their present or lower levels “at least through the first half of 2020”, which ensures that the accommodation is not weakened by market participants believing that interest rates could increase before this date. But it also entails a state-based element — that rates will remain at present or lower levels “in any case for as long as necessary to ensure the continued sustained convergence of inflation to the aim over the medium term”. This means that the ECB’s monetary policy is data-dependent and will evolve according to the inflation outlook.
As emphasised by the ECB, the forward guidance on policy interest rates, combined with the reinvestments of the sizeable amount of purchased assets and the new series of targeted longerterm refinancing operations, provides the significant monetary policy stimulus, which is needed to underpin the convergence of euro area inflation to the ECB’s aim. Given the current inflation outlook, a highly accommodative stance of monetary policy will likely still be needed for some time.
9. How would you respond to the criticism of low interest rates and the effects of low interest rates? How do you see the balance between unintended effects of the ECB’s interest rate policy and the convergence towards the envisaged medium-term inflation rate?
The ECB has a primary objective of maintaining price stability. The current monetary policy measures were introduced as a response to the post-crisis conditions in order to achieve the inflation aim.
Low interest rates — together with the other monetary policy measures adopted — have contributed to the disappearance of deflationary risks and to supporting economic growth and employment creation. However, it is clearly important to continue monitoring the possible side effects from accommodative monetary conditions not only in relation to the transmission of monetary policy but also to financial stability.
When it comes to understanding the impact of negative interest rates on euro area citizens, it is important to have a comprehensive approach looking at all the mechanisms at play. On the one hand, banks may decide to pass the negative deposit rate on to depositors, lowering the interest rates the latter get on their savings. On the other hand, the same depositors are also consumers, workers, and borrowers. As such they benefit from stronger economic momentum, lower unemployment and lower borrowing costs. All things considered, in the absence of the unconventional monetary policy adopted by the ECB — including the introduction of negative interest rates — euro area citizens would be, overall, worse off.
With regard to the impact of negative rates on banks’ profitability, empirical analysis suggests that the negative effects on banks’ net interest income have been so far more than offset by the benefits from more bank lending and lower costs for provisions and impairments due to the better macroeconomic environment, which to a significant extent is a result of accommodative monetary policy. Nevertheless, it is important to monitor whether adverse side effects may emerge in the future, the longer low interest rates are in place and use the available micro- and macro-prudential policy toolbox as necessary.
Overall, the low-yield environment needs to be understood in the context of the protracted decline in real yields since the 1980s. It is not unique to the euro area. It largely reflects more structural factors such as a slow-down in productivity growth, rising savings in anticipation of longer retirement periods, and safe-asset scarcity.
Full document
ECON-PR-639816_EN
The ECB just needs to outlaw cash. . .