Christian Noyer: The ECB is ready to fight deflation
Opinion piece by Mr Christian Noyer, Governor of the Bank of France and Chairman of the
Board of Directors of the Bank for International Settlements, in Wall Street Journal,
21 November 2013.
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There is a lot of talk nowadays about the risk of a "lost decade" in the euro zone, with a
conjunction of no growth and deflation. Current forecasts point to very low inflation in the
foreseeable future. For the euro area as a whole, inflation is projected to remain at around
1.5% in the coming year.
However, low inflation is very different from deflation. Deflation is a cumulative process of
decreasing prices, wages and output fueled by negative expectations. Deflation is a
pernicious spiral. It increases the burden of debt and creates an incentive to defer
consumption and investment. Deflation is especially dangerous because once the process
becomes entrenched, it becomes very difficult to stop.
At the moment there are no signs of general deflation in the euro area and most indicators
point to a very low risk. Inflation expectations in particular remain firmly anchored in positive
territory and, for the long term, stand at levels close to the European Central Bank's definition
of price stability.
As usual, inflation rates vary in the different economies of the euro area. In some peripheral
countries, inflation is particularly low. This, in a way, is a good thing, as it contributes to
restoring their competitiveness, as witnessed by their strong export growth. However, the
lower inflation is, the greater the risk that unexpected shocks could push the economy into
deflationary territory. Since this could, in turn, have consequences for overall euro-area
inflation, it is perfectly justified to ask what should be done to minimize that risk.
The best protection and the first line of defense against the risk of a lost decade is structural
reform. Structural reforms stimulate private consumption and make investment more
profitable. In particular, they increase the return on capital and, as a consequence, the
economy spontaneously moves towards an equilibrium with higher interest rates. In turn,
higher equilibrium interest rates would make it easier for the European Central Bank to set its
own policy rate at levels consistent with those needed by the economy. The chances that
monetary policy becomes constrained by the lower bound of 0% interest rates are reduced.
Higher equilibrium rates also benefit savers, a legitimate concern in many countries.
Basically, savers have a claim on future output. They are best protected when growth is
sustained and widespread, allowing them to earn high returns and diversify their risks.
That said, deflation, like inflation, is ultimately a monetary phenomenon. And central banks
must fight all risks to price stability with determination. Under the Eurosystem mandate,
which is the cornerstone of all our actions, price stability is our priority objective. The
definition of price stability is therefore an essential feature of our monetary framework.
Originally, when the euro was created, price stability was defined as a "less than 2%"
increase in the overall price index. That would theoretically allow for zero or even negative
inflation.
The definition was described as "asymmetric," meaning that the Eurosystem would react to
excess inflation but would be indifferent to low inflation or even deflation. But that was never
the intention. In 2003 the definition was adjusted in order to eliminate any ambiguity. Price
stability is now defined as "less than but close to 2%." The current definition is therefore fully
symmetric. It makes it clear that the central bank is equally concerned by inflation that is too
low or too high.
This is not only a question of semantics. Central banks' perceived objectives determine
expectations and the behavior of private agents. If a central bank is seen as equally
intolerant of both high and low inflation, the economy will more easily stabilize within the
acceptable inflation range. Stability of inflation expectations has improved the capacity of
euro-area economies to absorb the post-Lehman shock: While inflation became negative for
a few months in 2009, expectations did not change and deflation was never a threat. This
episode illustrates the credibility achieved by the Eurosystem in approaching price stability in
a symmetric fashion.
Together with the definition of price stability, the "two pillars" approach is another important
feature of the Eurosystem's framework. In parallel to assessing future economic prospects,
the European Central Bank's governing council looks independently at the dynamics of
money and credit aggregates. This has proved very useful in the past to detect long-term
risks to price stability, in both directions. The message today is clear: both money and credit
are growing very slowly in the euro area as a whole. The M3 money-supply aggregate grew
by 2.1% in September. These trends do not signal deflation, but warrant monitoring and
vigilance when facing an uncertain future.
Obviously, intentions may not always suffice and must be backed, when necessary, by
appropriate and timely actions. Recent decisions by the governing council regarding both
policy rates and liquidity provision show that we are ready to make the necessary decisions.
Many instruments remain available should further risks materialize. There should be no
doubt that the Eurosystem will ensure that price stability, as currently defined, will be
maintained in the euro area.