ECB CONFERENCE ON MONETARY

POLICY: BRIDGING SCIENCE AND

PRACTICE

Pablo Hernández de Cos

Governor, Banco de España

Frankfurt am Main

8 October 2019

2

IN THE LAST DECADE ADVANCED ECONOMIES HAVE BEEN EXPOSED TO PERSISTENT DISINFLATIONARY PRESSURES

SOURCE: Eurostat, Thomson Reuters Datastream. Last observation: 2019 August.

-3

-2

-1

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

EURO AREA UNITED STATES UNITED KINGDOM JAPAN

INFLATION%

European Stability Mechanism

First EBA stress test

Lehman failure

US taper tantrum

European Financial Stability Facility

Greece requests financial assistance

UK Brexit referendum

2 %

LOW INFLATION PERSISTS IN SPITE OF UNPRECEDENTED MONETARY POLICY STIMULUS

SOURCES: Datastream, European Central Bank and Banco de España.

Last observations: Rates,19 Sep 2019; Balance sheet: Eurosystem,12 Sep 2019; FED, 11 Sep 2019; BoJ, 09 Sep 2019; BoE.

-1

0

1

2

3

4

5

6

07 08 09 10 11 12 13 14 15 16 17 18 19

EUROSYSTEM

FEDERAL RESERVE

BANK OF JAPAN

BANK OF ENGLAND

%

POLICY INTEREST RATES

0

20

40

60

80

100

120

0

10

20

30

40

50

60

08 09 10 11 12 13 14 15 16 17 18 19

EUROSYSTEM

FEDERAL RESERVE

BANK OF JAPAN (right scale)

BANK OF ENGLAND

% of GDP 2017

CENTRAL BANKS BALANCE SHEET

% of GDP 2017

3

4

UNCONVENTIONAL MEASURES HAVE BEEN EFFECTIVE AT EASING FINANCIAL CONDITIONS, SUCH AS YIELD CURVES…

SOURCE: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming.

Notes: The chart shows the impact of ECB non-standard measures on the GDP-weighted

aggregate of euro area sovereign bond yields.

UPWARD PRESSURES ON EURO AREA SOVEREIGN BOND YIELDS

IN ABSENCE OF ECB’s NON-STANDARD MEASURES 2014-2018

% per annum

NEGATIVE INTEREST RATE POLICY (NIRP) FORWARD GUIDANCE (FG) APP

0.0

0.4

0.8

1.2

1.6

0.0

0.4

0.8

1.2

1.6

2y 5y 10y 2y 5y 10y 2y 5y 10y 2y 5y 10y 2y 5y 10y

2014 2015 2016 2017 2018

5

…AND AVERTING THE RISKS OF DEFLATIONARY SPIRALS AND STIMULATING GROWTH AND INFLATION

CONTRIBUTION OF ECB NON-STANDARD

MEASURES TO REAL GDP GROWTH

2014-2018

% per annum

Source: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming.

Notes: The chart shows the impact of ECB non-standard measures on macro variables based on a macroeconomic model with

financial variables conditioning on their estimated impact on the yield curve.

% per annum

CONTRIBUTION OF ECB NON-STANDARD

MEASURES TO HICP INFLATION

2014-2018

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2014 2015 2016 2017 2018

TLTRO NIRPFG APPReal GDP growth Counterfactual

-0.5

0.0

0.5

1.0

1.5

2.0

-0.5

0.0

0.5

1.0

1.5

2.0

2014 2015 2016 2017 2018

TLTRO NIRPFG APPHICP inflation Counterfactual

6

RESEARCH BASED ON MICRO DATA HAS YIELDED VALUABLE LESSONS ABOUT UNCONVENTIONAL MONETARY POLICY MEASURES

For instance, they enable us to document that:

• Refinancing programs have contributed to enhancing funding conditions and to

stimulating credit (e.g., Andreeva and Garcia-Posada, 2019; and Garcia-Posada and

Marchetti, 2016).

• Central bank asset purchase programs had positive effects on the cost of financing

and the supply of credit (e.g., Arce, Gimeno and Mayordomo, 2019).

• Negative interest rates: the effect on credit conditions is more difficult to assess as it

occurs through different channels (e.g., Arce, García-Posada, Mayordomo and Ongena,

2019, Heider, Saidi, and Schepens, 2019, and Demiralp, Eisenschmidt and Vlassopoulos, 2017).

7

GOING FORWARD, LOW/NEGATIVE RATES ARE LIKELY TO PERSIST, DUE TO A LOW ‘NATURAL’ INTEREST RATE

SOURCE : Banco de España Annual Report 2018, based on the model of Fiorentini, Galesi, Pérez-Quirós and

Sentana (2018). The bands for the euro area refer to confidence levels of 68% and 90%.

• The natural interest rate (r*) is a key determinant of policy interest rates

• Evidence of sustained decline in recent decades, reflecting different structural factors:

• demographics (e.g. Eggertsson and Mehrotra, 2014), low productivity growth (Gordon,

2015), safe asset scarcity (Caballero and Farhi, 2017), etc.

8

HOW SHOULD MONETARY POLICY BE CONDUCTED IN AN ENVIRONMENT OF LOWNATURAL INTEREST RATES?

• A low (and falling) r* implies that the incidence of the effective lower bound (ELB) may

increase in the future.

• If the reversal rate (Brunnermeier and Koby 2018) is higher than “switch-to-cash” ELB,

conventional policy space may be smaller:

• Evidence suggests that we have not yet reached the reversal rate…

• … but if rates remain negative for long this may end up hampering bank-based

monetary transmission (e.g. Arce, García-Posada, Mayordomo and Ongena, 2019).

• Adjusting our monetary policy strategy to this challenging environment should be a

priority

9

COMMUNICATION HAS PROVED TO BE A KEY MONETARY POLICY TOOL

• Forward guidance was proposed in the academic literature as a way to address the ELB

constraint (Eggertsson and Woodford, 2003).

• A commitment to provide a monetary stimulus longer than required by the central bank

reaction function (“low for longer”).

• Forward guidance requires credibility and transparency, both of which must be

centerpiece of (revised) monetary policy strategies.

SOURCE : Banco de España

Time

Inte

rest

rate

T1 T2 T3

ELB

No ELB “Low for longer”

ELB

Inflatio

n

T1 T2 T3

“Low for longer”

No ELB

ELB

Target level (e.g. 2%)

Time

Shadow rate

10

MONETARY POLICY CANNOT BE THE “ONLY GAME IN TOWN”

• The ELB imposes limits to conventional and unconventional monetary policy

• Other policies must play a role in providing stimulus when needed and alleviating such side

effects

• Countercyclical fiscal policy may help support growth and inflation:

• Positive synergies between monetary policy, fiscal policy and structural reforms under

the ELB (Arce, Hurtado, Thomas, 2016).

• Positive fiscal spillovers (Alloza, Burriel y Pérez, 2019).

• Macroprudential policies can help to alleviate some of the negative side effects associated

with unconventional monetary policy

11

IN THE EURO AREA, THERE ARE IMPORTANT CHALLENGES TO THE EFFECTIVE IMPLEMENTATION OF COUNTERCYCLICAL FISCAL POLICY

• Many EU members face limited fiscal space to enact expansionary fiscal policies.

• Potential asymmetry of national business cycles across the euro-area

SOURCE : European Commission.

NOTE: Fiscal space is computed as structural deficit – medium term objective

-3,0

-2,5

-2,0

-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5

2,0

LU DE CY MT LT AT NL IE EE SK FI LV PT BE SI FR IT ES

FISCAL SPACE IN EURO AREA

% potential GDP

12

TOWARDS A EURO AREA-WIDE FISCAL POLICY?

• Therefore we need a euro area-wide fiscal instrument powerful enough to:

• stabilize aggregate fluctuations in the area.

• help accommodate the impact of idiosyncratic shocks to EMU members.

• Risk sharing through fiscal policy plays a more important role in other more

complete monetary unions.

• Bonus: under additional conditions, euro area (supranational) debt would become a

union-wide safe asset.

0102030405060708090

100

1999 - 2015 1998 - 2014 1961 - 2006 1995 - 2006 2003 - 2016

Euro Area United States Canada Germany Spain

CAPITAL MARKETS FISCAL CHANNEL CREDIT MARKETS NON-SHARED RISK

STRENGTH OF RISK-SHARING CHANNELS (a)INTERNATIONAL COMPARISON

As % of GDP

SOURCE: Banco de España Annual Report 2016 and Burriel (forthcoming).

a Estimated following the methodology of Asdrubali et al (1996), which approximates the percentage of shocks recorded in an economy’s GDP that pass through to that economy’s residents’

income and consumption decisions. The channels that enable the impact of the shocks to be softened are, firstly, the capital markets channel whose strength depends on the income that

residents obtain from other countries not affected by the shock because they hold shares in the companies of those countries and obtain income from labour and from other financial assets.

Secondly, the shock may be softened by public intervention through fiscal transfers from the federal budget, as in the case of the United States, or from other regions (fiscal channel). Finally,

households and firms in that economy may smooth their consumption by resorting to their savings or to the credit market (credit channel).

13

BEYOND CYCLICAL STABILIZATION, FISCAL POLICY AND STRUCTURAL REFORMS MAY HELP TO RAISE THE NATURAL INTEREST RATE

• Structural reforms can boost economic activity (Andrés, Arce and Thomas, 2017) as well as

the potential growth rate.

• Fiscal policy can achieve a more growth-friendly composition of public finances (e.g.

public investment geared towards increases in productivity).

0

20

40

60

80

100

120

140

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

EMU FR DE ES IT

PUBLIC INVESTMENT AS A RATIO TO GDP

2007=100

SOURCE : Eurostat.

Thank you for your attention.