Sabine Lautenschläger: How innovative should central banks be?
Keynote speech by Ms Sabine Lautenschläger, Member of the Executive Board of the
European Central Bank, at the Wirtschaftsgipfel 2014 "Wirtschaft neu denken - die Kraft der
Innovation", organised by Süddeutsche Zeitung, Berlin, 29 November 2014.
* * *
Tradition and innovation in monetary policy
More than six years after the start of the global financial crisis, monetary policy in the euro
area still faces major challenges:
Monetary policy, the ECB, faces a challenge - perhaps more than ever before.
It faces a challenge because inflation rates are too low. At 0.4% for the whole euro area, the
inflation rate is well below our target of nearly 2%. The prospects for economic growth and
further price developments in the medium term are subdued. Monetary growth and lending
are weak. Geopolitical risks are adding to the uncertainties which are causing investor
appetite to continue to fall.
Expectations of the ECB are high, from markets and from politicians. Every month people
give us good advice, often referring to actions taken by other central banks. And they do so
despite the fact that our monetary policy decisions from June and September haven't yet
been able to fully take effect.
So what else can a central bank do in the current situation? How innovative may central
banks be? How innovative is an ECB allowed to be, which as a start-up from the year 1999 is
in many ways itself an innovation, and as a custodian of a currency without a state can only
partly be compared with other central banks. Of course I can only give you today, less than a
week before our ECB Governing Council meeting, some general reflections from my
personal point of view.
I think we can all readily agree that innovation cannot be an end in itself. The ECB must and
will act only in accordance with its mandate. Price stability is the guiding principle of our
actions. The definition of our mandate does not allow for innovations. Moreover, in uncertain
times of crisis a clear focus is not less, but doubly important. Central banks therefore have a
particularly strong understanding of tradition, and for a good reason: monetary policy is all
about trust, reliability and consistency.
Innovative measures must therefore be judged against our mandate of maintaining and
creating price stability. As with any decision, innovation demands a sober analysis of the
costs and benefits, the opportunities and risks. Allow me to slip briefly into legalese:
innovative monetary policy measures, too, should be suitable to achieve their objective.
Since monetary policy measures also have side effects, a central bank should use the
mildest means to achieve the fewest possible side effects.
Low inflation rates and the catalogue of measures
So what does this mean for the current situation? Unanimous monetary policy can and must
maintain price stability. No more and no less. We are judged on whether we achieve an
average rate of inflation for the euro area as a whole which is in line with our target of below,
but close to 2%. The commitment to price stability is symmetrical. That means that the ECB
must act exactly the same when the target is undershot for a sustained period as when it is
overshot. We take a medium-term view when it comes to achieving our target, because our
aim is to ensure price stability over the medium term.
At the moment, with an inflation rate of 0.4% for the whole euro area, we are a long way off
our target.
And in the coming years, too, we can only expect a moderate rise in the inflation rate. There
are a number of reasons why the challenges of monetary policy will probably continue to
occupy us for quite some time to come. Some banks will still have to adjust their balance
sheets, and this applies to an even greater extent to public finances, private companies and
households in some countries. This has a structurally dampening effect on overall economic
demand, and particularly on investments. Furthermore, important long-term determinants of
the real interest rate are pointing downwards: demographic trends, namely longer life
expectancy and weak population growth worldwide - but particularly pronounced in the euro
area - are creating an environment which necessitates low real interest rates and thus low
balanced nominal interest rates.
The euro area suffers from a lack of competitiveness and productivity, which of course take
different forms in individual Member States. Structural problems and current weak demand
lead to unsatisfactory economic growth and unacceptably high unemployment in many
countries. Tackling these challenges in the long term is not the job of monetary policy. Crisis
management must tackle the root causes for the long term and we, the ECB, will therefore
not tire of reminding governments that we can only provide them time for the urgently needed
reforms.
Against this backdrop we could ask whether it was appropriate that the ECB took action. I
think it was - precisely because of the path of inflation, even if there is room for discussion
about the some of the measures and their design. The list of our crisis management
measures is long. In June and September this year we lowered key interest rates further.
The main refinancing rate is now just 5 basis points. The interest rate channel has thus been
exhausted. For the first time in our history we have resorted to a negative deposit rate in an
effort to achieve the desired monetary policy accommodation within the tried and tested
corridor system. This justified monetary policy step - which favours investment - was not an
easy decision for us, not least because of its possible side effects for the financial sector and
for savers. At the same time, we have the tool of forward guidance, which we have used and
later reaffirmed: with regard to the inflation outlook, based on current data we expect that the
central bank interest rates in the euro area will remain at the current level for an extended
period.
In addition we have taken a number of targeted unconventional measures which should
improve the monetary policy transmission mechanism. One of these is targeted longer-term
refinancing operations (TLTROs), with which banks can obtain liquidity for a fixed interest
rate for up to four years. We have drafted two purchase programmes, one for covered bonds
and one for asset-backed securities (ABS). The purchase programme for covered bonds
started in October. So far purchases of around €16 billion have taken place. We started the
ABS programme just last week. I anticipate that together the longer-term refinancing
operations and both purchase programmes will have a strong impact on the balance sheet of
the Eurosystem.
Innovation or imitation
Every month there are fresh calls for further measures. But is it appropriate to contemplate
further measures at this moment in time?
Under normal conditions, central banks are in a position to ensure price stability in an
environment of positive nominal interest rates by means of conventional interest rate policy.
Once interest rates are at zero, a central bank is left with only unconventional measures in
order to fulfil its mandate. Central banks all over the world have indeed been anything but
idle. In particular they have significantly expanded their balance sheets, and by making
changes in their balance sheet structure they have taken various measures to make targeted
investments in submarkets affected by liquidity shortfalls, maintain important credit
relationships and ensure a functioning monetary policy transmission.
We, too, have turned to innovative measures, to the targeted longer-term refinancing
operations and the purchase of covered bonds and asset-backed securities which I
mentioned earlier.
For sure, in times such as these we need to be prepared. That is why the ECB's Governing
Council agreed at the beginning of November that the appropriateness of the monetary
policy stance should be closely observed. In concrete terms, this means that if it should
become necessary to further counteract the risks of a prolonged period of low inflation, the
Governing Council intends to take additional unconventional measures within its mandate.
Even if it is good to be prepared, one should beware of showing activism.
There is no automatic mechanism to initiate further programmes. The ECB's Governing
Council has not decided on a target for the size of the balance sheet; it has rather
unanimously expressed an expectation. A kind of mechanical expansion of the ECB's
balance sheet cannot be an end in itself. All of our decisions are to be evaluated against the
background of current and medium-term inflation expectations.
Consequently, we must continually analyse current price increases to identify the
components which comprise the weaknesses in price developments. Short-term
developments are not key, especially when they are largely determined by energy and food
prices. The underlying trend and the firm anchoring of inflation expectations are decisive, as
well as the orientation of the euro area as a whole. Low inflation rates in some Member
States - even when negative - are not in themselves a breach of the target. They can be
necessary to restore lost competitiveness. One could also argue about whether it is really
necessary to consider further measures given that the measures already taken have not yet
been able to have an effect. Monetary policy does not take effect immediately, but only with a
certain time lag. As a rule we should take this time and wait and see.
Which measures are we talking about here?
The large-scale purchase of securities, including government bonds, is often seen as a
panacea. As I said, even for innovative or unconventional measures, the costs and benefits,
and the opportunities and risks must be carefully considered.
Some central banks have used quantitative easing to quickly and decisively provide
monetary policy impetus, adjusted to the specificities of their environment. It is these
particular central banks and their measures to which we are compared. For me, these are
idle comparisons. The following saying applies here: those who constantly compare
themselves with others might become more like them, but they won't necessarily become
any better.
When making a comparison with the measures of other central banks, people often forget
that monetary policy measures, including unconventional ones, have to be adapted to the
institutional conditions, economic specifics and financing structure which make up a currency
area. Measures which are appropriate in one currency area can be ineffective elsewhere.
What seems like the first option in one place can be the very last resort elsewhere, without
the actual aim of the measures having to differ much from one another.
Instead, we should ask: would such purchases have the desired effect on the rate of
inflation? What "quantities" would need to be purchased to have an effect? How long would
such effects last?
The euro area is characterised by a bank-based financial system which makes it
considerably different from more strongly market-based financial systems, particularly in the
United Kingdom and the United States. This explains our focus on refinancing operations,
which have enabled the banking system to overcome liquidity bottlenecks, maintain credit
relationships and enter new credit arrangements. Our measures from June and September
2014 also serve to support the credit channel. In essence, it is about improving funding
conditions for borrowers in the real economy. The same logic can also be applied to the
selective purchase programmes for covered bonds and asset-backed securities.
The Eurosystem is currently faced with 18, soon to be 19, issuers of government securities.
Should we not take into account during a broad purchase programme of securities the fact
that government securities in the euro area are not without credit risk? There are very few
shared competencies in fiscal policy. As long as this is the case, the ECB's purchase of
government securities is inevitably linked to a serious incentive problem. After all, the
required cost-benefit considerations should also take into account the fact that other central
banks bought government securities in a different economic environment with considerably
higher long-term interest rates. In the euro area, the long-term interest rates on Spanish and
Italian government bonds, for example, are already lower than those from the United States
or the United Kingdom. It is therefore questionable whether we should "depress" interest
rates for the securities class even further.
Moreover, the interest on national government bonds in the euro area doesn't operate as a
benchmark for all further refinancing operations, as is the case in the United Kingdom or the
United States for example. Besides, the effect of intervening in capital markets in a
bankbased financial system is weaker than in a market-based system, as illustrated by wealth
effects, for example.
Therefore with regard to the purchase of government bonds, measures which are obvious in
one place could be the last resort at best for us - for instance when there is the threat of
deflation, but only if the cost-benefit analysis is favourable.
As you see, there are more questions than answers at the moment. In my view, a
consideration of the costs and benefits, and the opportunities and risks of a broad purchase
programme of government bonds does not give a positive outcome at the current time.
Concluding remarks
Owing to my position, I have limited myself today to talking about innovations in monetary
policy. At this point we should look first at the effect of our recent measures and of the asset
quality review and the stress test on bank lending.
Innovations in other political areas are also necessary, if not even more so. The reasons for
weak growth and funding shortfalls primarily lie elsewhere, not in a lack of central bank
liquidity, to say nothing of capital markets. Innovative political approaches are called for when
it comes to increasing growth potential in the euro area, strengthening economic adjustment
efforts and making budget consolidation compatible with growth and employment.
But let me conclude by returning to the original question: how innovative may the ECB's
monetary policy be? As innovative as necessary and as effective as possible. This requires
careful consideration. The risks and side effects must always be taken into account. For me,
given the current situation, the hurdles for further measures are very high, especially for
broad purchase programmes. The interest and spreads for many debt instruments are
already very low: the risk of market distortions cannot be dismissed. The deciding factor for
all programmes is their effectiveness for the real economy and ultimately for price stability,
which is what we - the ECB as the central bank for the whole euro area - must be judged
on. Innovation is not therefore a taboo, but neither can it be an end in itself.
I look forward to our discussion.