Benoît Coeuré: Domestic and cross-border spillovers of unconventional
monetary policies
Remarks by Mr Benoît Coeuré, Member of the Executive Board of the European Central
Bank, at the SNB-IMF Conference "Monetary Policy Challenges in a Changing World",
Zurich, 12 May 2015.
* * *
I would like to thank Roland Beck, Fédéric Holm-Hadulla and other colleagues at the ECB for their contribution to
the speech. I remain solely responsible for the opinions expressed herein.
Accompanying charts can be found at the end of the speech or on the European Central Bank's website.
Summary
Discussion has recently emerged on the global financial market implications of diverging
monetary policy cycles. Central banks in large advanced economies can free themselves
from the global financial cycle and regain monetary independence, provided that they show
clarity in purpose and resolve in implementation. The global exchange rate adjustments
should be therefore seen as a natural by-product of such move towards monetary policy
independence and divergence. Monetary policy always has unintended consequences, no
matter where it is pursued. At the ECB we take our decisions with a view to attaining our
primary objective of price stability. But without prejudice to this objective, we take financial
stability risk seriously and monitor closely whether severe imbalances are emerging in the
financial sector.
* * *
Dear Managing Director, dear President, ladies and gentlemen,
In recent years, there has been an intense discussion, both at the national and the
international level, about the potential financial market implications of unconventional
monetary policies.
At the international level, policy makers have been particularly concerned with the surge in
capital inflows, and the resulting exchange rate appreciation pressures in emerging markets.
More recently, amid monetary policy normalisation in the United States and additional
monetary policy easing in the euro area, including through the launch of the public sector
purchase programme (PSPP), a new, but conceptually related discussion has emerged on
the global financial market implications of diverging monetary policy cycles.
At the national level, the main concerns were spillovers to equity and real estate markets,
and the worries about the emergence of asset price bubbles as a result of unconventional
policy measures.
As responsible central bankers, we should be mindful of these two concerns. In my
presentation today, I would like to share my views with you on both.
International spillovers of diverging monetary policy cycles
Over recent quarters, macroeconomic conditions have diverged across major advanced
countries, with solid economic growth in the United States and the United Kingdom being
accompanied by a tepid recovery in Japan and until recently in the euro area. Given that the
central banks of the countries I have just mentioned have clear domestic mandates to fulfil,
this had inevitably led to diverging monetary policy cycles among major advanced
economies. At the same time, many emerging market economies (EMEs) are displaying
slowing growth rates, while also partly benefiting from the disinflationary impact of the decline
in oil prices, which creates additional leeway for monetary easing.
Taken these developments into account, the global economy is currently characterised by an
environment of diverging monetary policy cycles. While the US Federal Reserve (and to a
lesser extent the Bank of England) has signalled its willingness to embark on steps towards
monetary policy normalisation, many central banks across the world are on an easing bias -
in fact, more than 20 central banks have eased monetary policy since the start of 2015.
This pattern of global monetary policy divergence has per se not been unprecedented. In
fact, when considering interest rate level differentials between the United States and the euro
area as a simple indicator of differences in global monetary policy cycles, it appears that
current divergences are not out of line with what was happened in the past: while differences
in short-term policy rates currently do not reveal the full amount of divergence (see Chart 1,
black line) due to the zero lower bound, long-term interest rate differentials can give us a
better gauge for measuring differences in global cycles (see blue line). According to this
yardstick, global monetary policy divergence is indeed elevated, with the spread between the
US Treasury and German 10 year yields being today north of 150 basis points. But we have
had comparable episodes in the past, in particular when Europe was lagging behind the US
cycle, which happened in the early 2000s and again in the mid-2000s.
Importantly, global monetary policy divergence is also a sign of monetary policy autonomy. In
fact, while there has been a lot of discussion in recent years about a loss of monetary policy
independence in the presence of a global financial cycle (which Hélène Rey famously
referred to as the "dilemma, not trilemma")1, recent interest rate developments vividly
illustrate the independence of ECB monetary policy. You can think of the recent development
as a two stage process, triggered by the successive monetary policy decisions of the ECB. In
the first stage, short-term euro area interest rates were clearly de-coupled from US rates in
the summer 2013 when the ECB, in the wake of the Fed's taper tantrum, decided to issue its
own forward guidance. In the second stage, since August 2014 when the ECB announced
various credit easing packages and in particular since the announcement of the ECB's PSPP
in January, ECB unconventional monetary policy has become the main driver of long-term
interest rates in the euro area. Long-term rates have declined considerably in response to
the announcement, in line with our intention to further ease financing conditions in the euro
area, rising somewhat very recently as part of market correction of earlier gains (see
Chart 2). In this regard, the ECB's PSPP programme is having effects on notably term and
inflation risk premia that are similar to those witnessed previously in the Unites States. The
ensuing de-coupling of long-term interest rates can also be seen in dynamic correlations
between yields on 10 year German Bund and US Treasury bills which have declined (see
Chart 3).
The de-coupling of long-term rates shows that the well-known trilemma in the international
macro is still relevant, at least for large advanced economies. This holds true despite recent
evidence that argues in favour of a dominant global financial cycle triggered by the economic
centre's monetary policy (namely that of the United States), which influences other countries'
national monetary policies mainly through capital-flows, credit growth, and bank leverages,
making the types of exchange rate regime of the non-centre irrelevant. But as I have argued
above, predicting the end of the dilemma was maybe pre-mature in the case of large
advanced economies.
The lesson from our recent experience is that central banks in large advanced economies
can free themselves from the global financial cycle and regain monetary independence,
provided that they show clarity in purpose and resolve in implementation.
For emerging markets and smaller advanced economies, there is also evidence that while
the global financial cycle has indeed been a dominant factor for the last two decades, the
arrangement of open macro policies such as the exchange rate regime and financial
openness still have direct influence on sensitivity to the financial cycle2.
Explaining the difference in this respect between large advanced economies and EMEs
would take us far beyond today's discussion. Let me only suggest that the existence of deep,
diversified local currency denominated capital markets makes a crucial difference to help
decouple from the global financial cycle. This incidentally suggests that Capital Market Union
as it is currently planned in Europe, on top of its allocative benefits, can help strengthen our
economic and monetary independence.
The global exchange rate adjustments should be therefore seen as a natural by-product of
such move towards monetary policy independence and divergence. While the exchange rate
is not a policy target for the ECB, it is nonetheless important for growth and price stability.
Also, the exchange rate movements we have seen over the past few months are not
unprecedented relative to the experiences of other major central banks with regards to
announcements of quantitative easing policies (such as QE2 and QE3 in the United States
and QQE in Japan, as well as the Bank of England's APF).3
This notwithstanding, global policymakers need to be mindful that global monetary policy
divergence can also lead to some tensions that are due to global monetary policy spillovers.
Many discussions in the context of global monetary divergence have centred on the issue of
monetary policy spillovers and the exposure of emerging market economies to volatile capital
flows.
Yet, as I have argued elsewhere4, there is no broad international consensus on the size and
persistence of such spillovers.5 More generally, there is little evidence that capital flows to
emerging markets have been excessively volatile over most recent years, contrary to what is
often claimed. They have been strong since the global financial crisis, decreased somewhat
2
See Aizenman, J., Chinn M. and Ito. H, (2015) "Monetary Policy Spillovers and the Trilemma in the New
Normal: Periphery Country Sensitivity to Core Country Conditions", NBER Working Paper No. 21128, April
2015.
3
QE 1 which was implemented at the height of the financial crisis was followed by a sharp appreciation of the
US dollar. Similarly, the euro appreciated after the announcement of outright monetary transactions (OMT). In
both cases the main channel of transmission was a reduction of (global) risk aversion.
4
See "Policy coordination in a multipolar world", remarks by Benoît Coeuré, Member of the Executive Board of
the ECB, at the 5th annual Cusco conference organised by the Central Reserve Bank of Peru and the
Reinventing Bretton Woods Committee: "70 years after Bretton Woods: Managing the interconnectedness of
the world economy". Cusco, 22 July 2014.
5
See also Chen, Q., Filardo, A., He, D. and Zhu, F., "International Spillovers of Central Bank Balance Sheet
Policies", Working Papers, Bank for International Settlements, November 2011. It studies the macroeconomic
effects of US QE on 17 advanced and emerging economies in the period from 2007 to 2013. The authors find
that the estimated effects of US QE on the emerging economies - while quite diverse across countries - are in
many cases larger than those in the advanced economies, including the United States. In the case of the
ECB's unconventional monetary policy, international spillovers are likely to be more limited, however - at least
the empirical evidence available so far suggests that it did not lead to international portfolio rebalancing across
regions and assets. This may, however, have changed after the launch of the PSPP. See also Fratzscher, M.,
Lo Duca, M. and Straub, R., "ECB Unconventional Monetary Policy Actions: Market Impact, international
Spillovers and Transmission Channels", paper presented at the 15th Jacques Polak Annual Research
Conference hosted by the International Monetary Fund, 13 14 November, 2014; and Georgiadis, G. and Gräb,
J., "Global Financial Market Impact of the Announcement of the ECB's Extended Asset Purchase
Programme", Working Papers, No 232, Federal Reserve Bank of Dallas Globalization and Monetary Policy
Institute, March 2015.
during the taper tantrum in 2013 and do not appear to have been markedly influenced by
recent signals by the Federal Reserve towards monetary policy normalisation. With regard to
the PSPP, there is also no evidence that recent ECB measures have led to increased
international portfolio re-balancing from the euro area to emerging market economies.
While we need to keep an eye on international spillovers, it is not clear whether monetary
policy coordination would lead to a superior outcome. In particular, from a theoretical
perspective, it is not clear whether an optimal domestically oriented monetary actually leads
to more international spillovers.6
As recently argued by Charles Engel, research on monetary policy coordination is too scarce
to draw any firm conclusions7. In particular, it is not clear whether the optimal
noncooperative policy leads to more spillovers than would occur under a cooperative policy. In
addition, examples of successful co-ordination in the real world are few and limited to
exceptional crisis times as documented in an IMF study by Ostry and Gosh (2013)8, quite
apart from the political and institutional obstacles to such co-ordination, starting with the fact
that central banks have domestic, not global mandates.
But taking a sceptical view of formal policy coordination does not imply that the central banks
of the large advanced economies should not be mindful of the consequences of their actions.
This brings to mind two policy consequences. First, clear and consistent communication is of
the essence. Forward guidance has proven relevant and useful and it remains a valuable
asset in today's uncertain environment. Second, knowledge of monetary policy spillovers can
be enhanced. At the ECB, we are still learning about the transmission channels of our asset
purchase programme and their international consequences. And the extent to which the
spillovers from this programme to EMEs will offset those from US monetary policy
normalisation is yet to be understood. There remains much to be learnt by the global central
bank community when it comes to monetary policy spillovers.
Domestic spillovers
Turning to domestic spillovers, another question that has frequently been raised after
unconventional policies were launched is whether they are prone to create financial stability
risks in general and asset price bubbles in particular. Some have even argued that asset
price bubbles were necessary condition for economic recovery in the early 2000s.9 So, are
bubbles an unintended consequence of unconventional monetary policies that we should live
with?
First of all, monetary policy always has unintended consequences, no matter where it is
pursued. By altering short-term interest rates, central banks affect the inter-temporal
decisions of households. Inter-temporal redistribution is at the heart of monetary policy that is
aimed at ensuring price stability, and it thus has effects on the income distribution of savers
and spenders.
But monetary policy also affects the distribution of income along the intra-temporal and
spatial (cross-country) dimension. Changes in short-term interest rates affect consumption,
savings and wealth in different ways, depending on the characteristics of individual
households in different jurisdictions. But all these effects can be considered temporary,
indirect and unintended, i.e. a side effect of a strategy that is aimed at ensuring price stability
in the economy.10
That said, it would be a logical fallacy to conclude that all domestic spillovers are acceptable.
Bubbles are a case in point. Bubbles are a possible, but not an inevitable result of
unconventional monetary policies. And if they are welcome at all, then only in a severely
constrained, second-best world. But in this case, we should ask ourselves how we can
overcome the constraints that prevent better policy outcomes, rather than settling for bubbles
to temporarily mask the constraints.
Let me elaborate.
Facing the threat of a persistent low-growth and low-inflation environment and a binding floor
on standard policy rates, many central banks have resorted to unconventional measures.
These measures were aimed at further pushing down nominal interest rates along the
maturity spectrum to track the secular decrease in the natural, "Wicksellian" real rate of
interest. Thereby, they helped induce firms and households bring forward their investment
and consumption spending in comparison with that in a no policy-change scenario and,
ultimately, bring the natural rate back to more normal levels.
I am convinced that there is no alternative for us than acting this way in order to deliver on
our mandate. Yet, there is a danger associated with the temporary, yet potentially extended
period where low interest rates are needed to stimulate investment and consumption. With
real interest rates below potential growth, private agents may just borrow to purchase assets
in limited or rigid supply (e.g. real estate property). In this dynamically inefficient11 world with
structurally weak growth prospects, this may actually become an attractive way for savers to
generate returns on their savings that investments in the productive sector are unable to
generate.
In this case, we end up with a "rational bubble", which - as you will have noticed - follows
the dynamics prominently highlighted by Jean Tirole12. While unconventional monetary policy
is not a necessary condition for this type of bubble to emerge, it may render it more likely -
and more violent in the event of its materialising.
So what are the consequences of such bubble?
In the short-term, it may indeed generate a temporary boost to the economy. And for a while
this boost would be difficult to distinguish from the regular workings of asset purchase
programmes, which actually embed asset price increases as a desired effect, which passes
on the initial impulse to broader financing conditions via portfolio rebalancing.
But this boost would ultimately be very costly. Not only does it does it come with
welfaredecreasing macroeconomic instability, but it also brings about an arbitrary redistribution of
wealth that may, in the worst case, undermine social cohesion and trust that the central bank
is acting within its narrow price stability mandate. And moreover, it can create financial
stability risks elsewhere, generating negative spillovers from what should otherwise be a
normal international adjustment process.
Against this background, it would be wrong to treat bubbles as a welcome replacement
therapy to a sustainable growth model. Instead, macroeconomic and structural policies have
to set the necessary conditions so that investment in productive sectors becomes attractive
again and investment in bubble-prone areas is discouraged, so that total factor productivity is
increased and the natural rate of interest ultimately reverts to what is normal.
These principles underlie our views on the right policy mix for the euro area.
We take monetary policy decisions with a view to attaining our primary objective of price
stability. Thereby, we establish a stable nominal anchor for the private sector, which in turn is
a fundamental precondition for overall macroeconomic stability.
Without prejudice to this objective, we take financial stability risk seriously and monitor
closely whether severe imbalances are emerging in the financial sector. In this context, we
consider the financial stability risks related to our policy measures to be contained. Should
risks emerge, macro-prudential policy is best suited to safeguard financial stability.
Macroprudential instruments can be targeted more efficiently to those sectors and countries where
systemic risks may be materialising13. Finally, we encourage national authorities to do
whatever is in their power to place the euro area on a more dynamic growth path, thereby
creating attractive investment projects that generate high, but fundamentally justified, returns.
These are the conditions for unconventional monetary policies to bring economies back to a
stable and sustainable growth path, both at home and abroad.