Jean Claude-Trichet: Hearing before the Economic and Monetary Affairs
Committee of the European Parliament
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, before the
Economic and Monetary Affairs Committee of the European Parliament, Brussels,
10 September 2008.
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Madame la Présidente, Mesdames et Messieurs les membres de la Commission
Economique et Monétaire, je me réjouis de ce troisième échange de vues avec votre
commission au cours de cette année. Je commencerai mon intervention par une évaluation
de la situation économique et monétaire, en expliquant les raisons sous-jacentes à nos
récentes décisions de taux. Je me pencherai ensuite sur les développements sur les
marchés financiers en vous donnant de plus amples informations sur les opérations de
politique monétaire que la BCE a menées face aux tensions demeurant sur le marché
monétaire. Des Weiteren freue ich mich das von Ihnen aufgeworfene Thema der
Interdependenz zwischen den Vereinigten Staaten von Amerika und der Eurozone zu
erörtern. Zudem möchte ich näher auf die Entwicklung der Wettbewerbsfähigkeit innerhalb
der Eurozone eingehen. Abschließend erfolgt ein Inflationsausblick auch im Hinblick auf Ihre
Frage, ob eine Phase höherer Preissteigerungsraten vor uns liegen könnte.
Economic and monetary developments
Since my previous appearance before the European Parliament on 9 July when I presented
the ECB's Annual Report for 2007, annual inflation rates have remained at high levels well
above those consistent with price stability. This is mainly the result of both the direct and
indirect effects of past surges in international energy and food prices. In addition, upside
risks to price stability over the medium term have continued to prevail in a context where the
underlying pace of monetary expansion continues to be strong. Looking ahead, inflation in
the euro area is likely to remain high for quite some time, moderating only gradually during
the course of 2009.
According to the latest ECB staff projections the average annual inflation rate is foreseen
between 3.4% and 3.6% in 2008 and between 2.3% and 2.9% in 2009.
It is the Governing Council's view that the risks to this outlook are on the upside. In particular,
there is a very strong concern in the Governing Council that higher energy and food prices
may lead to the emergence of broad-based second-round effects in price and wage setting,
which in turn could add significantly to inflationary pressures. All parties concerned are called
upon to contribute to avoiding broad-based second-round effects, as this is essential to
ensure that longer-term inflation expectations remain firmly anchored in line with price
stability. In this context, the Governing Council is concerned about the existence of nominal
wage indexation schemes, as they involve the risk of triggering an inflationary wage-price
spiral. The Governing Council calls for these schemes to be abolished.
Turning to economic activity, in the second quarter of 2008, real GDP contracted by 0.2%
quarter on quarter. This reflects partly an expected technical reaction to the strong quarterly
growth of 0.7% in the first quarter. It also reflects dampening effects from global and
domestic factors, including high commodity prices and weaker investment growth in the euro
area. The current episode of weak economic growth is expected to be followed by a gradual
recovery. In particular, if persistent, the fall in oil prices from their peak in July will help
strengthen real disposable income, with the level of employment remaining high and the
unemployment rate low by historical standards. Moreover, euro area activity should be
supported by relatively resilient world growth, benefiting mainly from sustained growth in
emerging economies.
According to the latest ECB staff projections the average annual real GDP growth is foreseen
in a range between 1.1% and 1.7% in 2008 and between 0.6% and 1.8% in 2009.
In the view of the Governing Council, uncertainty surrounding growth prospects is particularly
high at the current juncture, with downside risks mainly relating to renewed increases in
energy and food prices and a potentially more negative impact of financial market
developments than currently foreseen.
The monetary analysis confirms the prevailing upside risks to price stability at medium to
longer horizons. While money and credit growth are now showing some signs of moderation,
the still strong underlying pace points to continued upside risks to price stability over the
medium term. In addition, available data suggest that the ongoing financial tensions have, as
yet, not significantly affected the availability of bank credit.
In accordance with its mandate, the Governing Council is resolute in its determination to
keep medium and long-term inflation expectations firmly anchored in line with price stability.
This will preserve purchasing power in the medium term and support sustainable economic
growth and employment. It is against this background that the Governing Council on 4
September decided to leave the key ECB interest rates unchanged. On the basis of its
assessment, the Governing Council believes that the current monetary policy stance will
contribute to achieving the objective of price stability over the medium term. Indeed, the
Governing Council will continue to monitor very closely all developments.
Financial stability situation and overview of the ECB's recent monetary policy
operations
Let me now turn to the developments as regards financial stability. Recent developments
suggest that the balance of risks in the ECB financial stability assessment remains tilted
towards the downside. This is because the persistent, although moderating, decline in US
house prices is leading to a rise in loan delinquencies and losses, and commensurate further
declines in mortgage backed securities prices. Also in the euro area, economic growth has
slowed down and credit risks could have increased in some housing markets and related
corporate sector loans. At the same time, however, there is little evidence to suggest that the
availability of bank credit in the euro area, as a whole, has been until now significantly
affected by the financial market tensions.
That said, as we already emphasised, the persistence of the financial market tensions may
have made the financial system more vulnerable to the crystallisation of other pre-existing
risks. These include the possibility of a more broad-based turn in the global credit cycle,
disorderly developments owing to global imbalances, and the financial stability implications of
volatile energy prices.
More generally, the outlook for euro area and global financial stability will increasingly
depend on the interaction between macroeconomic developments and the financial system,
and on how banks respond to a challenging operating environment. The financial market
correction could be gradually changing its nature and scope and evolve into a more
traditional credit-cycle downturn. In such circumstances, it is more likely that the adjustment
process will not abate as key participants in the financial system continue their efforts to
strengthen their liquidity and capital positions. In an environment where balance sheet
conditions change unexpectedly, there is no room for complacency.
In the last three months, the ECB continued to apply three measures it had used so far since
the start of the financial market turbulences, with a view to further steering very short term
money market rates close to the minimum bid rate and also to alleviate tensions in the euro
money market.
First, the ECB continued to frontload the supply of liquidity over the reserve maintenance
periods. This was achieved by increasing the allotment amounts in main refinancing
operations (MROs) at the beginning of the maintenance period while reducing them towards
the end of the maintenance period so that the average supply of liquidity remained
unchanged over the entire maintenance period.
Second, the ECB maintained the increased share of longer-term refinancing operations
visà-vis the share of main refinancing operations, which it had gradually built up since the start
of the turbulences. Moreover, on 4 September, the ECB decided to renew the supplementary
three and six month longer-term refinancing operations that will mature before the end of the
year. This will allow the euro area banks to better plan their liquidity management over the
turn of the year.
Third, the ECB continued to conduct USD term auction facilities (TAF) in cooperation with the
US Fed and other central banks. Accordingly, it provided US dollar liquidity to euro area
banks, secured with Eurosystem eligible collateral. This measure was adjusted in the period
under review. Indeed, in August 2008, an 84-day TAF was introduced to supplement the
already existent 28-day TAF, however without thereby increasing the total outstanding
amount of TAF operations.
The Eurosystem's collateral framework has proven robust and efficient over the years, and
during the recent episode of financial market turbulence. In particular, the acceptance of a
wide range of collateral contributes to the resilience of euro area financial markets.
While fully preserving this feature, the ECB has - following its biennial review - incorporated
some technical refinements in its risk control framework for Eurosystem credit operations.
These technical refinements, which were published on 4 September 2008, reflect, inter alia,
improvements in the methodological framework, the assessment of market and liquidity risk
characteristics of eligible assets, the actual use of eligible assets by counterparties and new
developments in financial instruments. All of these refinements will enter into force on 1
February 2009.
In concrete, these measures include the application of new valuation haircuts for
assetbacked securities (ABS) and uncovered bank bonds and the application of a haircut add-on
for ABS without a market price. Furthermore, the existing "close link rules" for the use of
eligible assets were refined. As regards the credit assessment of eligible assets, the
Eurosystem introduced rating disclosure standards applicable to rating agencies. Finally, it
was recalled that the Eurosystem has the right and obligation to react to practices that lead
to an inadequate risk protection for the Eurosystem.
The overall impact of the new haircuts for unsecured bank bonds and ABS on the availability
of collateral is not expected to impair the ability of banks to participate in Eurosystem credit
operations.
US-euro area interdependence
Let me now address the issue of interdependence between monetary policy conduct on both
sides of the Atlantic. In considering such interdependence, it should be clear from the outset
that both the ECB and the US Federal Reserve conduct monetary policy with a view to
achieving the domestic objectives that have been assigned to them.
The single monetary policy was given the task of maintaining price stability in the euro area
and was assigned to the ECB as an independent, supranational institution. I would like to
stress that public pronouncements made by the US Federal Reserve are pointing out as we
do ourselves that the delivery of price stability over the medium term is the best contribution
that monetary policy can make to sustainable economic growth, job creation and prosperity.
The Governing Council of the ECB - as the Open Market Committee does on the other side
of the Atlantic - takes decisions independently, on the basis of its monetary policy strategy,
taking into account the structural features of its economy and the nature and amplitude of the
economic shocks it has to cope with, and after careful assessment of the risks to price
stability in its economy.
Of course, it is important for a stability-oriented monetary policy to analyse developments in
external prices, in international trade and financial flows as well as the spillovers of policy
actions around the globe. Central Banks have to take into account the multiple channels
through which the major economies of the world are in close relationship, thus constituting a
global economy. In that sense, it is very important for central banks to ensure that they
exchange pertinent information.
As I already mentioned before, central bank staff and Governors of industrialised countries
as well as of emerging countries meet every two months under the auspices of the Bank for
International Settlements in Basel. Presently, I happen to be the Chairman of the Global
Economy Meeting and I can tell you that this meeting in particular is important for all central
banks. In a very frank and direct fashion and with a high degree of mutual confidence we
compare notes, exchange all necessary information so as to be duly enlightened on the
analysis and diagnosis that other central banks are making of their own domestic economies
and on their perception of the global issues.
Against the backdrop of the serious market correction recorded since summer 2007,
monetary authorities on both sides of the Atlantic have been cooperating to help ensuring a
smoother functioning of inter-bank markets and help alleviating liquidity drying up in some
market segments.
Intra-euro area competitiveness developments
Persistent inflation and wage growth differentials may occur in a monetary union, determined
by catching-up processes and/or by sustainable trend differentials in potential growth across
countries. However, if induced by structural inefficiencies, misaligned national policies
including wage-setting policies or overly optimistic expectations, such differentials may be
worrisome and may have important adverse implications for cost competitiveness of
individual countries in the euro area. As national monetary and exchange rate policies are no
longer available options within the euro area, it is important to ensure that the remaining
mechanisms of adjustment to shocks function properly and that the build-up of imbalances is
avoided.
Rigidities in price and wage-setting mechanisms or ongoing excessive price and wage
developments may delay the necessary adjustments of relative prices to economic shocks
and give rise to a prolonged period of relatively high inflation in some countries. This, in turn,
could contribute to losses in price and cost competitiveness and an accumulation of internal
imbalances within the euro area, which could also dampen output and employment. When
looking at unit labour costs, it is also noticeable that a number of euro area countries which
experienced significant increases in unit labour costs since their entry into the euro area, also
show relatively high current account deficits.
National authorities have an important responsibility to contribute to moderate price and unit
labour costs developments. It should in particular be avoided that public wage-setting
contributes to strong overall unit labour costs growth. As high unit labour costs growth may
also reflect an overheating of the economy, the avoidance of a pro-cyclical fiscal stance is
particularly important. Furthermore, a key issue is the capacity of goods and labour markets
to adjust. Therefore, wage agreements in particular should generally reflect the
competitiveness position, and need to take into account the still high level of unemployment
in many economies as well as the sector specific productivity developments. Finally, the
efficient and smooth functioning of economic adjustments within the euro area requires the
completion of the Single Market and thus greater domestic and cross-border competition.
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Let me conclude by briefly addressing the Committee's concern over whether we are
experiencing a new and lasting upward shift in inflation. The central bank is precisely there to
prevent such a lasting shift and to deliver price stability over the medium term. On the basis
of the assessment of the Governing Council the current monetary policy stance will
contribute to achieving this objective. The Governing Council remains resolute in its
determination to keep inflation expectations solidly anchored in line with price stability. At the
same time, upside risks to price stability over the medium term, in particular those stemming
from second-round effects in price and wage setting, prevail. In this context, in order to avoid
that the current high inflation rates become entrenched in expectations, it is of the essence
that all relevant parties - price setters and social partners - meet their responsibilities. As
emphasised, it is also important that indexation schemes are abolished. This would
strengthen the resilience of growth and employment creation of the euro area economy with
regard to the current adverse developments we have to confront.